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It has shortened the time and narrowed the world to us. Currently there are more than 1600 Airline Company working throughout the world and only quarters of them are quoted company. [1] Despite of financial crisis in 1997 to 1998 and 9/11 attack in USA, airline industry still remains one of the largest and fast growing industries in the world. In the past decade, airlines industry has grown 6. 6% per year. IATA (International Air Transport Association) forecasted that air industry will grow by an average 6. 6% a year to the end of the decade and over 7% a year from 2000 to 2010. 4] Another research carried out by the IATA reveled that Scheduled airlines carried 1. 5 billion passenger’s last year world wide. The main reasons for growing airline industry that fast are international investments and rapid increase of international supply, production chains and customers, rapid growth of lovely tourist destinations etc. [pic] Airline industry is considered as capital intensive industry. It needs big investment for huge range of expensive equipment and airplane, from airplanes to flight simulators to maintenance hangars, aircraft tugs, airport counter space, gates etc.
Consequently airline industry has become one of the most capital intensive industries in the world that require large amount of money to operate effectively. E. g. Ryan air is one of the most successful airlines in Europe. They have 23 European bases which employed 3 billion worth of capital. It also needs thousands of people to run effectively. ____________________________________________________________ _________________________ 1http://www. airlineupdate. com/data_pages/airlines/airline_country_index. htm#i 2 http://www. airlineupdate. om/data_pages/airlines/ireland. htm 3 http://www. ryanair. com/site/EN/about. php? page=About=GB=HEAD 4. http://adg. stanford. edu/aa241/intro/airlineindustry. html Risk managing was cheaper for airline industry in 2006. $7. 2 billion was spent in 2006 where $8. 3 billion was spent on 2005. [6] Airline Business and Aon’s survey on worlds top 50 Airline Company revels that airline companies account 1. 6% of their total revenue for the risk management which cost less than $1 per passenger. [6] Primary risk of the company arises from the high fuel price.
The gross profit margins and the net profit margins vary from business to business and from industry to industry. Following there is a list of service industry and their gross / net profit margin. | |International Airlines |Discount Airline |Leisure & Hotels |Pizza Restaurants | |Gross Profit Margin [7] |5. 62% |27. 46% |9. 64% |47. 52% | |Net Profit margin [8] |4. 05% |10. 87% |7. 36% |7. 5% | 2007 was really a good year for the airline industry. In 2007, the total net sales increased by 7. 3% comparing to 2006. IATA forecasted that total net sale for airline industry will be $90. 6 billion which will lead to a $5. 6 billion profit for 2007. [9] But the net sales as well as the profit for 2008 seems will go down because of the high fuel price. E. g. rising fuel prices and higher maintenance costs have lead MaxJet to bankruptcy. ____________________________________________________________ ________________________ a b c “Directory: World Airlines”, Flight International, 2007-04-03, P101-102. 6. Jenner, Gillian. 2007. Airline Business: Risk Management- Premium rate, 14. (6): 74-76, June 2007 7. http://www. bized. co. uk/compfact/ratios/profit3. htm 8. http://www. bized. co. uk/compfact/ratios/profit4. htm 9. International herald Tribune, airline Industry Profit Heading for Decline in 2008, December 12, 2007 Company analysis Ryan Air Ryanair is one of the largest and successful airline carrier of Europe based in Dublin and its biggest operational base is in London Stansted Airport.
Ryanair was found by Cathal and Declan Ryan in 1985 with only one 15 sets aircraft flying from Waterford to London. After 20 years in 2008, Ryanair fly’s to 628 low fare routes across 26 European countries. [10] ? Ryanair operates relatively in a low risky environment because its own airport base. ? Business runs through all year. ? Revenue is sensitive to fuel price and foreign exchange cost. Ryan airs passenger statistic. Source: www. ryanair. com ? Total operating cost in 2007were €1765m where fixed are €499m and variable costs are €1257. ? Ryanair has grown massively. Revenues have isen from €231m in 1998 to some €2237 m in 2007. ? The company is expanding as the operating revenue increase 32%. [11] and operates through the Europe ? Ryanair holdings subsidiaries are [12] |Subsidiaries |% of share |Operating Base |Nature of Business | |Ryanair Limited |100 |Dublin |Airline operator | |Darley Investments Ltd |100 |Dublin |Investment holding | |Ryanair. om Limited |100 |Dublin |International data processing | | | | |services | |Coinside Limited |100 |Dublin |Investment holding company | |Aer Lingus |29. 44 |Dublin |Airline Company | Table: Ryanair’s subsidiary ____________________________________________________________ ___________ 10. http://www. ryanair. com/site/EN/about. php? page=About&sec=story 11. http://www. ryanair. com/site/about/invest/docs/2007/070920annualreport. pdf 12. http://www. ryanair. com/site/about/invest/docs/2007/070920annualreport. pdf Dividend policy No dividends paid in last 3 year. Acquisitions/divestments During the year Ryanair acquired 15 Boeing 737-800 at a cost of €495million. [13] No divestment took place. All the acquisition is funded mostly by long-term borrowing and retrained profit. Asset quality Ryanair has a high quality asset mostly aircraft.
Resell value (book value) of this fixed assets are €2884m and it could be sell for money anytime. Total asset value in balance sheet is €5,691m. Loans are secured by the aircraft. Shareholders: From 2005 to 2007 1. 16m share were issued with a premium of €3. 09 on average per share. ? The airline is thinking of 200million share buy back [14] ? In 2007, ordinary shares of €1. 27 were splited( 2 for 1) into ordinary shares of €0. 00635 cent. ? Nominal value of the share is €. 0635 and market value is €3. 52 [15] ? Ryanair’s major share holders are follows [pic] ? Total market value of equity is €5262. 3 and book value is €982m [16] ? Debt to Market value of equity ratio is 1. 67 ? Book value of equity to total debt ratio is . 32 ____________________________________________________________ _________ 13. http://www. ryanair. com/site/EN/about. php? page=About=story 14. http://home. eircom. net/content/irelandcom/topstories/12140500? view=Eircomnet=Top%20Stories 15. Based on Irish stock exchange price on 08/02. 08 16. http://www. ryanair. com/site/about/invest/docs/2007/070920annualreport. pdf [pic] Graph: Ryanair share price (source: Irish stock exchange) [17] Lenders/Borrowings Ryanair has an AAA credit rating. [18] ? Current tax liability is €20. 822m (2007 b/s) ? Debt/total asset ratio is . 73 ? Interest coverage is 51. 11. [19] • Ratios Please see appendix -3 Aer Lingus Aer Lingus Group Plc is registered in Ireland which is the oldest airline company in Ireland that primarily provides air-passenger transportation services. Currently it has celebrated 10 million bookings through their website since 2001 and will be celebrating its 72nd birthday in April 2008. ? Aer Lingus was founded in April 1936 by the Irish Government and floated at 27 September 2006 in ISE. It operates in a very competitive market where it has to compit with many low fare airlines such as Ryan air. ? Business runs all the year round. ? Revenue is usually very sensitive to the fuel price and foreign exchange rate. ? Total operating cost of 2006 was €1084m (63% fixed and 37% variable. ) [21] ? Aer Lingus is a slow growing company. PBIT for 2006 was 77. 4 million which 5 % less than 2005 (81. 5 m) [22]. In 2005 they were operating in 64 destinations with 34 Aircraft fleet where in 2006, 6 new destinations and only 1 new airbus have been added. [23] ?
Aer Lingus operates throughout USA, Europe and Middle East. ____________________________________________________________ ____________ 17. http://www. ise. ie/app/equityHGraph. asp? INSTRUMENT_ID=47628 18.. www. independent. co. uk/… /analysis-and-features/ryanair-aims-to-become-europes-biggest-carrier-668170. html 19. http://stocks. us. reuters. com/stocks/ratios. asp? symbol=RYA. I#Financial%20Strength 20. http://www. londonstockexchange. com/en-gb/pricesnews/investorcentre/companyprofile/CompanyProfileResults . htm? token=775C0B14070A1D6048475B16435E775C0F464C0F1B37555D5A4A1041750A 0C48535C4E36 21] http://www. aerlingus. com/Corporate/Current_Report/AL_AnnualReport2006. pdf [22] http://www. aerlingus. com/Corporate/preliminary_results06. pdf [23] http://www. aerlingus. com/cgi-bin/obel01im1/Corporate/med_fleet. jsp? ? Aer Lingus groups only subside is Aer Lingus Beachey Limited (aircraft financer) in the Isle of Man as an. [24] and 20% interest in Futura, a Spanish company. • Dividend Policy Aer Lingus did not pay any dividend for the last 3 year. Net profits were transferred to retrain earning. Acquisition/Investment In the year of 2005, they bought and leased 12 aircraft and 2006 they bought 1 airbus.
All the acquisitions were funded by borrowing & retrained profit (2005) and equity share (2006) Asset Quality Aer Lingus has high level of assets that can be sold anytime for cash. Most of the assets are fixed assets. Total value of assets is €1. 95 billion in balance sheet. Loans are secured by plant and property, mainly aircraft. Asset available for sale is estimated to €118. 9m according to balance sheet 06. Shareholders ? The changes between 2005 and 2006 issued share is 102. 4% as they were listed in stock exchange in 2006. ? Market price of the share is €2. 336 and book value is €0. 05 issued at 31st December 2006.
During the year, a share split occurred; ordinary shares of €1. 25 each were splited into ordinary shares of €0. 05 each. [24] [pic]Pie chart: Share holders [21] http://www. aerlingus. com/Corporate/Current_Report/AL_AnnualReport2006. pdf [22] http://www. aerlingus. com/Corporate/preliminary_results06. pdf [23] http://www. aerlingus. com/cgi-bin/obel01im1/Corporate/med_fleet. jsp? [24] http://www. aerlingus. com/Corporate/Current_Report/AL_AnnualReport2005. pdf ? The market value of the equity share in 2008 is €1. 27 billion (Irish stock exchange share price on 20 January 2008) Total book value of equity is € 826 million.
Book value of equity debt ratio is 1. 73 and market value of equity debt ratio is 2. 11 (based on 2007 primary report) [25] [pic] [pic] AER LINGUS GROUP PLC ORD EUR0. 05 [pic] FTSE 100 Source: London Stock Exchange Ratios (please see appendix-4) Easy jet Originally the name Easy Jet is related to an American Quarter Horse foaled in 1967 which was the sire of race horses. However, the name Easy Jet became familiar to European people when Sir Stelios Haji-Ioannou found EasyJet in 1995. EasyJet was one of the first airlines who took the opportunity to provide online booking service to customer in April 1998. 26] • EasyJet is a newly formed company, aged only 13 year • EasyJet operates in competitive marketplaces against both flag carriers and other low cost airlines in UK. [27] • EasyJet’s business runs through all the year • Revenue is sensitive to change in fuel price and exchange rate with dollar.. • Total operating cost for the year 2007 was ? 1229m (fixed cost 48% and 52% variable) • Easy Jet is a fast growing company with a growth rate of 15% in the medium term. EPS for 2004 was 11. 10p and in 2007 it went to 36. 62p that clearly says the company is growing fast. 28] • The business is expanding. On average it has introduced a new A319 to the fleet every 13 days since 2004. [28] ____________________________________________________________ ____________ 25. http://www. aerlingus. com/Corporate/interim_results_2007_presentation. pdf 26. http://www. easyjet. com/EN/About/index. html 27. http://www. easyjet. com/common/img/annual_report_accounts_2007. pdf 28. http://www. easyjet. com/common/img/annual_report_accounts_2007. pdf • EasyJet is operating throughout Europe, Egypt and Morocco. • EasyJet is a subsidiary of Easy group. • Dividend Policy
EasyJet didn’t pay any dividend in 2007 and 2006. All the profits were transferred to retrained earnings, Acquisitions/divestments In the year 2007, EasyJet acquired 15 aircraft and negotiating on acquiring of GB airlines. Aircrafts was financed mainly by borrowing and leasing. Asset Quality EasyJet has a high level of tangible assets, mainly aircrafts. Most of the tangible assets can be sold in ready market for money. Total value of net asset in balance sheet is ? 1152. 4m. Loans are secured by the aircraft. Shareholders Total market value of the equity is ? 1956. 15m [29] where book value of equity is ? 19. 1m. The company didn’t issue any bonus or right share but issued 8. 6 m shares under employment share schemes. Book value per share is 25p and market value is ? 4. 6675 [30] Market value of equity to total debt ratio is . 45 where book value of equity to total debt ratio is 1. 86 [pic] Pie Chart: Easy Jets shareholder ____________________________________________________________ ____________ 29. http://www. easyjet. com/common/img/annual_report_accounts_2007. pdf 30. Based on London Stock Exchange share price on 01/01/07? 4. 6675 per share [pic] [pic] EASYJET PLC ORD 25P pic] FTSE 100 Share price movement Source: London stock Exchange Ratios (please see Appendices) British Airways British Airways is one of the world’s largest international airlines which is the national flag carrier of United Kingdom. BA started as a private company in 1935 and floated in London stock exchange in 1987. BA’s primary bases are London Heathrow and Gatwick airport. ? BA’s profit and total sales revenue is highly sensitive to the change in fuel price. BA made ? 602000 profit from fuel surcharge in 2007. On an average every customer paid ? 65 on the top of ticket price. [31] ?
BA’s business runs all the year long but summer is usually is known as high season. ? 59% of total operation cost is fixed cost and rest 61% is variable cost. (Total ? 7. 9 million). Operating cost for the year 2007 is 6. 3% more than previous year, mostly are fuel and employee cost. ? British Airways is a medium fast growing company. Current growth rate is 4. 6% [32] ? The company is expanding itself. Currently they are operating to 222 destinations and planning to lunch more 16 new destinations in 2008. They company currently own 289 fleet and more 10 will be delivered with in next two year. 33] ? BA operates in domestic and international market around the world. ? The company has 2 subsidies and both of them are operated from London. They are BA City flyers and Open skies. Both of them are fully owned by British Airways. • Dividend policy ? BA didn’t pay any dividend in last three year. ? The Board has intent to return the payment of dividends in the future as it reaches its target of a ten per cent operating margin. [34] ____________________________________________________________ ____________________________________ 31. http://media. corporate-ir. et/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf 32. http://stocks. us. reuters. com/stocks/ratios. asp? symbol=BAY. L 33 http://media. corporateir. net/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf 34. http://media. corporate-ir. net/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf • Acquisitions/divestment ? The group bought 9. 95% share of Iberia airlines and 15% investment in Myflybe group. [35] ? Fund for those investments was raised by selling one of its regional Business of BA Connect, 6. 2% Comair Ltd share, aircraft and London eye shares. • Asset Quality
The group has high level of tangible and intangible assets. Most of these tangible assets are freehold premises and aircraft. There are ready markets for this tangible asset.. All the loans are secured by BA aircrafts to lender. Total value of asset in balance sheet is ? 11,384 million. [36] • Shareholders [pic] Table: Shareholder of BA ? No new share was issued to external shareholder but to the employee for the last three years. ? Total number of issued share to 31st march 2007 was 1151. 56 million with a nominal value of 25p each. ? Current market price is ? 3. 04 [5] ? Total equity market value ? 3500. 5 million. Total book value of equity is ? 2411 million. Group’s debt to market value of equity to ratio is 1. 51 and debt to book value of equity ratio is 2. 82. ____________________________________________________________ ___________ 35. http://media. corporateir. net/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf 36. http://media. corporateir. net/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf 37. Based on London Stock exchange price for 23/01/08 [pic] [pic] BRITISH AIRWAYS PLC ORD 25P [pic] FTSE 100 Groups share price movement, Source: London stock Exchange Lenders/ Borrowings Credit rating went down to BBB- from BB+ [38] ? The company has 8 lending source so far. (please see index) [39] ? Debt total asset ratio is . 97 (London stock exchange)[40] ? Interest cover is 16. 7times. 41 • Ratios (please see appendix-1) Airline industry is capital intensive industry as it requires a high level of investment. Historically largest airline companies are government funded or was funded by the government. Though airline companies made losses since 1997 due to financial disaster and terrorist attack in USA, IATA said 2008 is going to be profit making year for airline industry.
Though airline industry made losses in last decade, still its one of the world’s fast growing company because of global mobility. ____________________________________________________________ ____________ 38. http://www. reuters. com/article/bondsNews/idUSL2079107920070620 39. http://media. corporateir. net/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf 40. http://www. londonstockexchange. com/en-gb/pricesnews/investorcentre/ companyprofile/Company ProfileResults. htm? token=20585815550F4F6348155845425E775708454C561C60045D0A404443215A 5D43505A4C 41. http://stocks. us. euters. com/stocks/overview. asp? symbol=BA. I Summary of analyzed companies’ performance | |Aer Lingus |British Airways | Ryan Air |Easy Jet | |Turnover |€1115. 81m |? 8492m |€2236. 90m |? 1797. 20m | |Net profit/loss |€-69. 93m |? 438m |€435. 60 m |? 152. 30m | |Total Asset |€1914. 71m |? 11384m |€5691. 5m |? 2516. 40m | |Total Equity |€816. 31m |? 2411m |€2539. 77m |? 1152. 40m | |Total Liability |€1924. 71 |? 11384 |€5691. 25m |? 2516. 40m | |Gearing Ratios |35. 55 |68. 68 |42. 30 |20. 11 | |Interest cover |-4. 7 times |5. 39 times |5. 51Times |4. times | |P/E ratios | |12. 15 |9. 51 | | |EPS |-20c |25. 50p |28. 20c |36. 62p | |Dividend per share |0 |0 |0 |0 | |Payout ratio |0 |0 |0 |0 | |Operating margin |-9. 6 |7. 09 |21. 9 |9. 57 | |Profitability ratios: | | | | | |ROCE |-7. 90% |1. 47% |10. 08. % |9. 08% | |Liquidity ratios | | | | | |Current ratios |1. 75 |0. 7 |1. 07 |1. 88 | |Acid test ratio |1. 75 Times | |1. 05 | | |Debt/equity ratio |. 55 |1. 51 |. 73 |. 45 | |Net Gearing |-312. 14 |30. 95 |-15. 24 |-55. 08 | |Beta | |2. 21 |1. 19 |. 7 | |Book value of Share | | | | | | |. 05c |25p |. 00635c |25p | |Market value per share | | | | | | |€2. 336 |? 3. 04 |€3. 52 |? 4. 6675 | ___________________________________________________________ ____________ 42. http://stocks. us. reuters. com/stocks/ratios. asp? symbol=RYA. I 43. http://www. londonstockexchange. com/en-gb/pricesnews/investorcentre/companyprofile/CompanyProfileResults. htm? token=265E0C4352574B6148430D4B4D5E77560E444C561A6A515D5E4A16157259 0F44525D1B60 44. http://www. londonstockexchange. com/en-gb/pricesnews/investorcentre/companyprofile/CompanyProfile Results. htm? token=755A5E48570F1A6348405716465E775E08454C0C4B665D5D5E114D42210A 5A14595C1D33 45. http://www. londonstockexchange. om/en-gb/pricesnews/investorcentre/companyprofile/CompanyProfile Results. htm? token=20595C12035B4D6348445C46465E77090B134C571D60515D0A174346250B 5F16035C1A3 Application of Theories The theories of capital structure are probably the most puzzling issues in the field of corporate finance. Theorists have been trying to find out the answer about what really determine the company capital structure. To find out the answer, many theorists have tried to formulate deferent theories about an optimal capital structure. But do capital structure really follows those theories?
We as a group will try to answer this question in this part of our assignment. The word capital structure refers to the combination of assets and liabilities through which a company finance itself. This combination includes equity, debt/borrowings or debentures. E. g. If Portobello College finance itself with €60million equity share and €40million debt then its capital structure is made with 60% equity and 40% Theories of capital Structure. ? Modigliani Miller theory: It is said that MM theory forms the basis of the modern thinking of capital structure.
MM theory says that the finance method does not increase the value of the company if the firm operates in the efficient market with the absence of bankruptcy cost, taxes and asymmetric information. In the perfect market, the Kd remain constant when the gearing level goes up and Keg increases as much the Kd dose and that lead to a constant level of WACC at any level of borrowing. The assumption behind this theory are as follows according to Davis & Pointon(1994:173) [46] • All investors have complete knowledge about future return. All firms within an industry have the same risk regardless of capital structure • No taxes • No transactions costs • A person can borrow as the same interest rate of company • All profits are paid out as dividends • WACC is constant. % Ks Ka Kd Debt/Equity ____________________________________________________________ __________________________ 46. Davis & Pointon, (1994), Finance and the Firm, 2nd ed . New York, Oxford University Press MM theory provides two proportion, with tax and with out tax. Proportion 1: Vg= Vu.
That means that the market value of the geared company is the same as the market value of the ungeared company % Ks Ka before-tax Ka after tax Kd before-tax Kd after-tax Proportion 2: Keg= Keu+ {(Keu-Kd) ? D/E}. that means that the Kd remain constant when the gearing level goes up and Keg increases as much the Kd dose and that lead to a constant level of WACC at any level of borrowing. ? Traditional Theory: The traditional theory of capital structure says that a company can increase its value by using a mixer of debt and equity capital structure with the assumption of existence of the optimal capital structure.
The traditional theory says that a company can decrease its WACC and increase its value by using a mixture of debt and equity. To prove that it says that debt finance is cheaper than equity finance on the basis that debt interest can be use as expenses which is tax exempt. In low level of borrowing, the difference between the two financing method will reduce WACC which will increase company value. However, Ke will increase as shareholder will look for more return on their investment as a result of increase in debt. (Financial risk).
On the other hand, Kd will remain constant to a certain level of borrowing and after that it will increase. Therefore, a company should figure out a suitable combination of capital structure which will decrease the WACC of the company and maximize company value by increasing shareholders wealth. (Power, T et al :2005,187) ? Trade-off-theory: Trade off theory is an add-on of MM theory. It is known as trade off theory because it consider firms equity/debt decision as a trade off between tax shield and financial trouble. 46.
Power,T et al(2005),Financial Management- An Irish text book, Gill and Macmilan Ltd, Dublin. P-186 The trade-off theory of capital structure refers to the idea that by balancing the costs and benefits, a company should choose the debt/equity capital structure. It says that “a company will borrow to the point where the marginal value of tax shields on additional debt is just offset by the increase in the present value of possible cost of financial trouble”. (Millar, Merton H May32. 2. pp. 261) [47] Source: Wikkipedia. com Financial trouble refers to the bankruptcy cost of debt and non-bankruptcy cost.
This model assumes that every firm has a target debt ratio which they adjust by comparing actual debt ratio with the predetermined debt ratio. So the firms who are above their target debt ratio should decreases their debt and vice-versa assuming that the marginal value of debt benefit is grater than the cost of debt which will maximize shareholders wealth. [48] Trade off theory can not answer why a company like Microsoft is successful with a little amount of debt in their capital structure where Microsoft pays a huge amount of tax.
In real life, most profitable company such as Microsoft borrow less and this is what trade off theory can not answer why? However, Airline Companies such as Easy jet, Ryanair, Aer Lingus and BA’s capital structure also supports the tax shield of the trade off theory. Those airlines are heavily financed by finance lease because lease payments are used as a tax shield for those companies. Empirical study carried by Lewis and Schallheim proved that leases and debt are substitutes and frames choose easing within the optimal capital structure choice. They show that leasing can actually increase a firm’s debt capacity by selling excess non-debt tax shield [49] ____________________________________________________________ ___________ 47. Miller, Merton and Charles Upton, (1976), Leasing, Buying and the Cost of Capital Services, Journal of Finance, 1976 Vol. 31, pp. 761-786. 48. http://www. efmaefm. org/efma2005/papers/250-swinnen_paper. pdf 49. http://www. studyfinance. com/jfsd/pdffiles/v7n3/erickson. pdf
That answers why dose airline company such as BA, Ryanair, EasyJet or Aer Lingus uses finance lease or debt finance a lot. ? Pecking order theory The pecking order theory is presented by Myers and Majluf(1984). It states that with the presence of asymmetric information, a company should finance itself firstly with internal source such as retrained profit then debt capital and equity finance should be last choice. It also state that managers of a company knows more asymmetric information about the company then other people.
If a manager issue new share when the real value of share is higher then actual, it will lead to a decrease in share price. That’s why pecking order theory states that new share will be issued only when the company is running out of its debt issue capacity and if it’s in financial trouble. Empirical study carried out by Baskin and Toy found that debt ratios is positively related to the need for funds (growth) and negatively related to the availability of internally generated fund. [50] Pecking order theory can explain why Microsoft borrows less money and use internal funds.
But this theory can not explain why a company such as Ryanair with a credit rating AAA raise both equity and debt capital (2005-2007) where it could raise more debt capital rather than issuing new share. [51] Airline is a capital intensive industry and mostly lease financed. Empirical study carried out by Erickson and Trevino(1994) stated “when the lease choice is framed within the financial pecking order, it is shown that for firms with similar profitability and growth, leases and debt are indeed substitutes. ” (Erickson and Trevino 7, 3, P. 1) [52] BA, Easy jet, Ryanair or Aer Lingus’s capital structure can be explain using pecking order theory. Most airplanes of these air companies are acquired by finance lease. These airlines have transferred their net profit to the retrained reserve for last few years without paying any dividend. All the capital investments are financed by the internal source and long term debt such as finance lease/borrowing. These companies are issuing shares (except Ryanair) but they are mostly for the employee benefit share.
Easy Jets borrowing has became almost double then previous year. These companies have higher credit rating and they can borrow debt which is obviously cheaper then the equity finance. Their capital structure clearly support by peaking order theory and they proved ‘Debt is good for you’ ? Agency theory: The main issue that agency theory represents is how to resolve the conflict between shareholders and management over the control of corporate resources through the use of contracts which seek to assign decision rights and incentives.
Agency theory state that too many organization expanding activity dose not maximize the wealth of the share holder but managements self-aggrandizement increase the shareholders wealth. The limitation of Agency theory is that agency theory does not consider competitive environments and management’s necessity to make choices beyond a stockholder wealth-maximizing perspective. [53] ____________________________________________________________ ____________ 50. http://www. studyfinance. com/jfsd/pdffiles/v7n3/erickson. pdf 51. http://www. efmaefm. org/efma2005/papers/250-swinnen_paper. df 52. Erickson and Trevino(1994),A Pecking order approach to leasing: the airline industry case, Journal of Financial and Strategic Decisions, 7, (3):71, July 1994 53. http://www. westga. edu/~bquest/2002/rethinking. htm Practical factor that affect companies capital structure Practical factor that affect companies capital structure are as follows ? Tax rate ? Asset base ? Cash flow volatility ? Interest rate level ? Stock market performance ? Article of association ? Foreign currency operation ? Issue cost ? Management preference ? Industry norms ? Operating gearing Agency effect etc (Power, T et al :2005,194) [54] For more than a decade theorist have been trying to explain the nature of capital structure that a company uses. As a group, we think that it is not possible to determine company’s capital structure all the time. Most of the time capital structure depends on the nature of the business and the company itself, how it wants to be financed. E. g. In airline industry, lease/debt financing is common regardless of company size where in medicine industry larger company like Pfizer with a credit rating of an AAA [55] has a little debt.
A lot of company dose not follow any theory at all, they choose whatever combination fulfill their need. ____________________________________________________________ ___________ 54. Power,T et al(2005),Financial Management- An Irish text book, Gill and Macmilan Ltd, Dublin. P-194 55. http://www. sec. gov/news/extra/credrate/pfizerinc. htm References ? Davis & Pointon, (1994), Finance and the Firm, 2nd ed . New York, Oxford University Press ? Power,T et al(2005),Financial Management- An Irish text book, Gill and Macmillan Ltd, Dublin. P-186, 194 ? ABC “Directory: World Airlines”, Flight International, 4(3) P101-102, April, 2007 ?
Erickson and Trevino,A Pecking order approach to leasing: the airline industry case, Journal of Financial and Strategic Decisions, 7, (3):71, July 1994[online] Available in http://www. studyfinance. com/jfsd/pdffiles/v7n3/erickson. pdf (Access date: 03/03/08) ? International herald Tribune, airline Industry Profit Heading for Decline in 2008, December 12, 2007 [online] Available in http://www. iht. com/articles/2007/12/12/business/air. php (29/12/07) ? Jenner, Gillian. 2007. Risk Management- Premium rate, Airline Business: 14. (6): 74-76, June 2007 ?
Miller, Merton and Charles Upton, Leasing, Buying and the Cost of Capital Services, Journal of Finance, Vol. 31, pp. 761-786. 1976[online] Available in http://www. efmaefm. org/efma2005/papers/250-swinnen_paper. pdf (Access date: 03/03/08) Web references ? http://www. airlineupdate. com/data_pages/airlines/airline_country_index. htm#i (Access date: 26/12/07) ? http://www. airlineupdate. com/data_pages/airlines/ireland. htm ? 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L(Access date: 23/02/08) ? http://media. corporateir. net/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf (Access date: 23/02/08) ? http://www. reuters. com/article/bondsNews/idUSL2079107920070620 (Access date: 28/02/08) http://media. corporateir. net/media_files/irol/69/69499/Annual_Report_and_Accounts. pdf (Access date: 23/02/08) Appendix 1 British Airways Ratio Analysis |Ratios name | 2007 | 2006 | 2005 | |Gearing Ratios |68. 68 |79. 53 |62. 14 | |Cash Interest cover |5. 39 times |6. 38 times |4. 24 times | |P/E ratios |12. 5 |13. 06 |9. 49 | |EPS |25. 50p |40. 40p |35. 20p | |Dividend per share |0 |0 |0 | |Payout ratio |0 |0 |0 | |Profitability ratios: |1. 47% |1. 38% |1. 9% | |ROCE | | | | |Liquidity ratios: | | | | |Current ratios |0. 97 |1. 07 |0. 84 | |Bankruptcy ratios | | | | |Debt/equity ratio |1. 51 |2. 19 |3. 9 | |Net Gearing |30. 96 |46. 86 |71. 15 | |Beta |2. 21 |2. 21 |1. 24 | |Interest covers |3. 03times |2. 80times |1. 89times | Note: 1 P/E Ratio=Market price pear share/Earning per share. 2007 2006 2005 = (3. 097/. 2550) = 12. 15 (5. 275/. 4040) = 13. 06 (3. 4/. 3520) = 9. 49 Source: yahoo finance ROCE = PBIT/ Capital employed. 2007 2006 2005 = (11384/7759) = 1. 47% (12174/8792) = 1. 38% (11671/8402) = 1. 39% Interest cover = PBIT/ interest payable. 2007 2006 2005 = (602/199) = 3. 03times. (705/252) = 2. 80times. (556/294) = 1. 89times Cash Interest cover = operational cash flow/ interest payments 2007 2006 2005 (1072/199) = 5. 39times. (1607/252)= 6. 38times. 1247/294) = 4. 24times. Appendix-2 Aer Lingus Ratio Analysis | |2006 |2005 |2004 | |Gearing ratios |35. 55 |57. 94 |60. 24 | |Interest cover |-4. 7times |8. 8times |2. 7times | |P/E ratios | | | | |Earnings per share |-20. 00 |31. 0 |8. 60 | |Dividend per share |00. 00 |00. 00 |00. 00 | |Payout ratio |00. 00 |00. 00 |00. 00 | | | | | | |Profitability ratios: | | | | |ROCE ratio |-7. 0% |8. 93% |2. 48% | |Liquidity ratios: | | | | |Current ratio |1. 75 |1. 29 |0. 9 | |Acid test ratio |1. 75times |1. 29times |0. 1times | | | | | | |Debt/equity ratio |0. 55 |1. 38 |1. 52 | | | | | | Note: ROCE = PBIT/Capital employed. 2006 2005 2004 = (-101. 05/1278. 81)= -7. 90% (89. 86/1006. 33) = 8. 93% (20. 01/807. 5) = 2. 8% Interest cover = PBIT/ interest payable. 2006 2005 2004 = (-101. 05/26. 87)= -3. 76times (89. 86/26. 48)=3. 39times (20. 01/26. 16)=0. 76 times Acid test ratio= (current asset-stock)/current liabilities. 2006 2005 2004 = (1134. 97-0. 73)/645. 90 = (627. 80-1. 05)/487 = (532. 46-0. 77)/582. 17 =1. 75times =1. 29times =0. 91times P/E Ratio=Market price pear share/Earning per share. 2007 2006 2005
Appendix-3 Ryan air Ratio analysis | |2007 |2006 |2005 | |Gearing ratios |42. 30 |45. 72 |44. 93 | |Interest cover |5. 51times |6. 27times |6. 25times | |P/E ratios | | | | |Earnings per share |28. 0 |40. 00 |36. 85 | |Dividend per share |0. 00 |0. 00 |0. 00 | |Payout ratio |0. 00 |0. 00 |0. 00 | |Accounting rate of return | | | | |Profitability ratios: | | | | ROCE |10. 08% |12. 45% |11. 83% | |Liquidity ratios: | | | | |Current ratio |2. 11 |2. 43 |2. 55 | |Debt/equity ratio |0. 73 |0. 84 |0. 82 | |Beta |1. 9 |1. 19 |0. 90 | | | | | | Note: ROCE = PBIT/Capital employed. 2007 2006 2005 = (461. 43/4573. 52) = (471. 75/3788. 35) = (375. 05/3168. 85) = 10. 08% = 12. 45% = 11. 83% Interest cover= PBIT/ interest payable. 007 2006 2005 = (461. 43/83. 78) = (471. 75/75. 19) = (375. 05/59. 93) = 5. 51times = 6. 27times =6. 25times P/E Ratio=Market price pear share/Earning per share. 2007 2006 2005 Appendix-4 Easy jet: | |2007 |2006 |2005 | |Gearing ratios |31. 06 |32. 80