British Airways Management of Company Finance

Ahoussou kouadio Jean Christian Student minute 2522706 Management of federation finance Analysis of the financial structure of British Airways Name of professor Tony Kilmister British airways is whizz of the most valuable caller-up in the world that is why I choose her. With the aim to approximate the proportion of debt in British airways, we result study his financial power train income geared wheel and capital gear. In couch to calculate the fellowships capital caravan according to the book measure out, we need especially the measure of the long- name and short-term strikeings and the value of shareholders funds.But, in that location is some(prenominal) different formulas which arises well-nigh issues the detail that the book value is set about than the trade value (the offset formula) and provisions can be diged either as liabilities or assets (the gage formula), depending on tauten. Then I go away calculate the Weighted fairish appeal of slap-up. In 2 004, the way of doing the balance wheel sheets changed thats why there are some differences between dickens reports. Part 1 beatnik of the accommodate and income ratioPart -2 Measure of the debt and equity based upon the grocery store value Part 3 Estimation of the WACC. I) Measure of gearing and income ratios We will take those expressions 1. Debt to equity ratio=Long term Liabilities/Shareholdersfunds 2. Debt to debt improver equity ratio=LTL/(LTL+ Shareholdersfunds) 3. Long Term Borrowings/Shareholders funds a) Gearing balance Capital Gearing = LTL / Shareholders hard cash 2006 2005 2004 Capital Gearing 259. 75% 437. 6% 590. 7% To set an upper ratio we can incorpo regulate the LTL at the shareholder value. Capital Gearing = LTL / (LTL + Shareholders Funds) 2006 2005 2004 Capital Gearing 72. 2% 81. 4% 85. 5% The provision are incorporates in those 2 formulas.We can consider that the provision can be take as liabilities ( grittyly certain) or as equity (ultra-prude nce). Capital Gearing = Long Term Borrowing (LTL provisions) / Shareholders Funds 2006 2005 2004 Capital Gearing 193. 5% 341. 4 % 475,40% Net Debt Net debt = (Finance debt cash and liquid resources)/ Equity For British Airways, Net debt = (loans, finance absorbs and hire grease ones palms arrangements + standardized Capital Bonds, net of other underway interest accusation deposits and cash and cash equivalents overdrafts) British Airways definition from the annual report 2006) ? one million million million 2006 2005 2004 Capital Gearing 1641 2922 4158 The figures of long term liabilities are spunkyer than the net debt that explain the fact that the ratios are different The guild health bet less vital, beca substance abuse of the cash and those equivalent, and deposits. Overdrafts are not representing a big measurement, we acknowledge them. Since 2004 a policy of high liquidity is developed in order to reduce the debt, they tried to repay the debt earlier.The debt are reduced by the variation of the 112 millions of convertible bonds. The ? 320 million 9 3/4 per cent Convertible Capital Bonds 2005 issued in 1989 matured on June 15, 2005. On that date 47,979,486 mundane shares were issued in exchange for 112,317,274 Convertible Capital Bonds on the basis of one ordinary share for every 2. 34 Bonds held (British Airways Report 2006). The capital gearing of the smart set is around 65% in almost all gearing indicators and more in som of them, as a conclusion we can check out that the financial statement of the company is risk of exposurey and more the company is shoddy due to the payment on the debt.We can similarly highlight the fact that British Airways is finance by debt. Its has a important amount of lease and purchase arrangement, which exceeds the bank loans. b) Income Gearing This ratios show us the security of creditors fund and the debt exposure. While employ Income Ration we highlight the relation of the companys income and it s interest commitments. Income Ratio = following payable / Profit in front Interest and Tax % 2006 2005 2004 Income Gearing 0,17 0,26 0,87 Interest are taking a lower place in the profit (strategy reduction of debt). In fact, we use the Interest cover to see if the company can meet its interest. Interest cover = Profit before interest and tax / Interest charges multiplication 2006 2005 2004 Interest Cover 5,79 3,80 1,15 The company can afford her interest. 1) Because of the decrease of the amount of debt, 2) The profit before tax and interest developmentd by 269%, the risk is less important.We can also use another formula, which gives a intermit image of the finance. It based on the fact that cash has not been received. As a conclusion we can sound outs that British Airways reduced its long term debt by 28. 5%, and keep their interest payment low and increase the PBIT strongly. From the shareholder point of view, the company takes high risks so they have a good return on inv estment although reduction of the debt of the company irritates the rate of return lower and lower. II) Measure of the debt and equity based on the foodstuff value a) appreciate of Equity Share Price*Number of Shares* 2004 ? 2,181 083 845 000 2005 ? ,941 082 903 000 2006 ? 2,791 cxxx 882 000 *I took those which were in the report. *The difference in the number of shares between 2005 and 2006 is the modulation of the 112 millions of Convertible Bonds into 47,979,486 shares. The value of equity is now ? 2006 2005 2004 Value of Equity 3 155 160 780 2 100 831 820 2 362 782 100 b)Rating Value of Debt pic The rating shows that the company take risks for financing because she invest in high return share in the junk bond or high yield market those are really unstable.This means that the company is passing financing by debt, investor need an important rate of return regards to the risk of non payment. In spite of that, British Airwayss main source of outside(a) funding is less sensit ive to credit rating than the unsecured bond. The opposition of the credit ration is not important for some parts of the debt. We will use the faire value of the debt to calculate the market value of debt. Because of the fair determine of the Euro-Sterling notes and Euro-Sterling Bond 2016 are based on the quoted market values at March 31, 2006.The fair values of floating rate borrowings are deemed to be equal to their carrying values. British Airways Report Example in March, thirty-first 2006 pic food market value of the debt is ? million 2006 2005 2004 Market Value of Debt 4 130 4 682 5 954 admit Value of Debt 4 081 4 492 5 716 The enigma is Those market values are blending the current liabilities.In the dissolve to respect the ratios made before, I will deduct with percentage the current liabilities. The new market value of debt is ? million 2006 2005 2004 Market Value of Debt 3645 4216 5244 Book Value of Debt 3 602 4 045 5 034 There is the a market where Debt are tr ade daily, that explain the difference between familys. ) Measure of gearing based on market values We use here the gearing ratio to compare the book value and the market value of the company Capital Gearing = LTL / Shareholders Funds % 2006 2005 2004 Capital Gearing 115,5 200,7 221,9 We can make a second ratio in order to set an upper limit Capital Gearing = LTL / (LTL + Shareholders Funds) % 2006 2005 2004 Capital Gearing 53,6 66,7 68,9 Figures are lower than the one we made with the book value. The equity are valued in the book value at 25p whereas in the market value at an average price of the three classs at 230p This divergence makes the ratios lower, then with the book values the company seems to be less indebted and also less risky to investors.III) Estimation of the Weighted Average Cost of Capital (WACC) a) Cost of Equity To estimate the approach of equity, we can use two ways 1) the dividend valuation model 2) the Capital Asset Price gravel (CAPM). In this case, we can not use the dividend valuation model because the company did not distri onlye dividends since 2001, so the cost of equity will be 0 that would lead to irrelevant results. British Airways has not distributed dividends because -They wants to strengthen the balance sheet by making new investment, then it invests into the company Quantas and also into the 5th Terminal in Heathrow.British Airways is the 13th highest performing company out of the 93 FTSE 100 companies remaining for the performance period April,1st 2003 to March, 31st 2006. The board of director indicated that the payment of dividends will be resumed at an suppress time. To calculate the cost of equity, the CAPM is the only model available Ke = Rf + ? (Rm Rf) Rf ( the risk-free return Rm ( the market risk ? ( quantitative measure of the capriciousness of a given stock, mutual fund, or portfolio, relative to the overall market.A beta above 1 is more volatile than the overall market, patch a beta below 1 is less v olatile. For British Airways, the genus Beta is, for the three years, 0,91. The risk-free return can be found in the website of the Bank of England for each years and the market risk is the caps of the FTSE 100 of year N less years N-1 divided by the caps year N-1 (Caps N caps N-1) / caps N-1 The risk-free return rate is 2004 4,75% 2005 5,1% 2006 4,2% The market risk is 31. 03. 2006 31. 03. 2005 31. 03. 004 Caps FTSE 100 5964,6 4894,4 4385,7 year N year N-1 1070,2 508,7 772,4 Market Risk (%) 21,87 11,60 21,38 The Cost of Equity using the CAPM is % 2006 2005 2004 Cost of Equity 20,1 10,9 19,7 ) Cost of debt In order to obtain the cost of debt, the best ratio is to divide the interest payable by the debt % 2006 2005 2004 Cost Of Debt 2,62 3,01 3,50 They leads to the homogeneous conclusion decrease in Debt and interest. We can add that no debt has been taken in 2006. All the purchase have been made by internal cash flow. c) The WACC The Weighted Average Cost of Capital is utilise to measure the cost of capital.The formula is Ko = Ke (Ve/Vo) + Kd (Vd/Vo) Where Ke (the cost of equity Ve (the value of equity Kd (the cost of debt Vd (the value of debt Vo (the total value of the firm ? million 2006 2005 2004 Vo 7 236 6 593 8 079 The WACC is % 2006 2005 2004 WACC 10,08 5,41 8,04 The amount of Debt decreased but the WACC stay in the average, that because of the high level of the cost of equity. 2005 is discernible by a share price lower than the two other years. This leads to a lower shareholders funds and also an higher influence of the debts drop, because the lower WACC. However, the CAPM have some limitations. He is based on several assumptions The investors are rational and risk-adverse who set a level of risk. The investors have the same single-period planning horizon. The investors have homogeneous expectations on the future yield. The investors can borrow and lend unlimited amounts at a risk-free rate. There is neither taxes nor cost of tran sactions The investors have all an efficient portfolio which maximize the yield, for a level of risk given. Whole of efficient portfolio form a wreathe called the efficiency frontier To conclude, from the point of view of market value, we can say that British airways succeeded to face its commitments in term of debt and equity. Indeed, they took advantage of an increase in share price. The repayment of share allowing to reduce the gearing in debt capital.