Airfrance Analysis

AIRFRANCE-KLM COMPANY ANNALYSIS

LEA

Lecturer: Prof. Dr. Ralf Hafner

Name: Kevin Gichimu (s0541454)

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Contents 1.0 AIR FRANCE-KLM SA COMPANY PROFILE ..........................................................3

1.1 General information ...............................................................................................3

1.2 Structure .....................................................................................................................3

1.3 Management ................................................................................................................4

1.3.1 Organization of the Board of Directors as of May 20, 2014 ...............................4

1.3.2 Executive Management Committee .....................................................................4

1.3.3 Possible sources of conflict of interest between the management and

shareholders ..................................................................................................................5

1.4 Financial markets & interaction with investors. .......................................................5

1.5 Social obligations ........................................................................................................5

1.6 Shareholders Breakdown ...........................................................................................6

2.0 FINANCIAL ANALYSIS ...............................................................................................7

2.0.1 Air France-KLM Common-Size Balance Sheet ......................................................7

2.0.2 Air France –KLM Common-Size Income Statement .............................................8

2.1 Net Working Capital ......................................................................................................9

2.2 Average tax rate ..............................................................................................................9

2.3. Return on Equity (ROE) ...............................................................................................9

2.4 Return on Assets (ROA) .................................................................................................9

2.5 Return on Capital ......................................................................................................... 10

2.6 Market Value Added and Market Book Ratio ............................................................ 10

2.7 EFFICIENCY RATIOS ............................................................................................... 10

2.7.1 Asset Turnover Ratio ............................................................................................. 10

2.7.2 Receivables Turnover ............................................................................................ 11

2.7.3 Average collection Period ...................................................................................... 11

2.8 Profitability Ratios........................................................................................................ 11

2.8.1 Profit Margin ......................................................................................................... 11

2.8.2 Operating profit margin ........................................................................................ 12

2.9 LEVERAGE RATIOS .................................................................................................. 12

2.9.1 Long-Term Debt Ratio........................................................................................... 12

2.9.2 Long-Term Debt Equity Ratio .............................................................................. 12

2.9.3 Total Debt ratio ...................................................................................................... 12

2.9.4 Times Interest Earned ........................................................................................... 13

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2.10 DU-Point System ......................................................................................................... 13

3.1 Risk profile .................................................................................................................... 14

3.1.1 Competition ............................................................................................................ 14

3.1.2 Jet fuel risks ........................................................................................................... 14

3.1.3 Foreign currency risk ............................................................................................ 14

3.1.4 Other Risks ............................................................................................................. 15

4.0 Stock Performance profile ............................................................................................ 15

5.0 COST OF CAPITAL .................................................................................................... 16

5.1 Optimal debt ratio .................................................................................................... 17

6.0 PROJECTS ................................................................................................................... 17

6.0.1 Current project ...................................................................................................... 17

6.0.2 Typical project ....................................................................................................... 17

7.0 Financing ....................................................................................................................... 18

7.1 Debt ........................................................................................................................... 18

7.2 Equity financing ........................................................................................................ 19

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1.0 AIR FRANCE-KLM SA COMPANY PROFILE

1.1 General information

Air France-KLM SA, a limited liability company registered under French law on 5 May 2004 as a

result of a mutual agreement between Air France and Netherlands-based KLM. It`s the second-

largest airline in Europe after Deutsche Lufthansa and is headquartered in Paris France. Through

its operating units, Air France and KLM operate independently from hubs in Paris-Charles de

Gaulle and Amsterdam- Schiphol, and also have coordinated operations, both as sister companies

and as members of the Sky Team alliance.

The company`s principal activity is passenger transportation, contributing roughly 80% of the

Group’s revenues, among other activities that includes cargo, aeronautics maintenance and other

air-transport-related activities comprising of in-flight catering and charter services. The Airline

serves more than 230 destinations in 125 countries with a fleet of 552 aircrafts. In 2013, the

airline carried 77.3 million passengers and 1.3 million tons of cargo.

1.2 Structure

The company also holds vast minority ownership in a couple of other international airlines as

illustrated in table 1.

Airline % Of Ownership

Kenya Airline 26

Air Côte D’ivoire 20

Air Corsica 12

Alitalia 7,08

Air Tahiti 7

Air Mauritius 3

Royal Air Maroc 3

Air Calédonie 2 Table 1

Air France KLM

(Listed company)

KLM

(Operating Company)

Air France

(Operating Company)

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1.3 Management

Shareholders are involved in electing eleven of the fourteen Board of Directors. As a requirement

two of them have to be representatives of the employee shareholders, while the remaining three slots are allocated to French State that’s represented though ministerial orders appointments.

The Board of Directors determines the direction of the Group's activities and ensures that they are

implemented in accordance to the plan. Furthermore, it’s mandated to work with the General

Management to ensure smooth company operations in line with the opinions and recommendations of its specialized committees.

Alexandre de Juniac serves as the Chairman of the Board of Directors and the group Chief

Executive Officer. This establishes a link between the Board and Management therefore ensuring that the Management acts to the best interest of the shareholders.

The company has a Supervisory Board in place that comprises of independently appointed

directors mandated with the duties of monitoring the management. Table 2 and 3 shows the composition of Air France-KLM SA Board of Directors and Executive management respectively.

1.3.1 Organization of the Board of Directors as of May 20, 2014

Name Position Alexandre de Juniac. Chairman and C.E.O

Peter F. Hartman Vice Chairman Of the Board of Directors

Régine Brehier Representative of the French State

Jean-Dominique Comolli Representative of the French State

Solenne Lepage Representative of the French State

Christian Magne Representative of the ground staff and cabin crews

Louis Jobard Representative of flight deck crew

Jean-François Dehecq Member Of the Board of Director

Jaap de Hoop Scheffer Member Of the Board of Director

Cornelis J.A van Lede Member Of the Board of Director

Isabelle Bouillot Member Of the Board of Director

Maryse Aulagnon Member Of the Board of Director

Isabelle Parize Member Of the Board of Director

Leo M. van Wijk Member Of the Board of Director Table 2

1.3.2 Executive Management Committee

Name Position

Frederic Gagey C.E.O Air France

Camiel Eurlings C.E.O KLM

Alain Bassil C.O.O Air France

Pieter Elbers C.O.O KLM

Patrick Alexandre EVP Commercial-Passenger Business

Pieter Bootsma EVP Commercial Marketing-Passenger Business:

Bram Gräber EVP Strategy-Passenger Business

Wim Kooijman EVP Human Resources

Jean-Christophe Lalanne EVP Information Technology

Franck Terner EVP Engineering and Maintenance

Erik Varwijk EVP Cargo

Jacques Le Pape EVP Corporate Secretary

Pierre-François Riolacci Chief Financial Officer

Table 3

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1.3.3 Possible sources of conflict of interest between the management and

shareholders

a) Since they use the principle of one share one vote, shareholders who hold more shares by

de facto have more voting power in enforcing crucial company’s decisions including

elections of members to the .Board of Directors. This may lead to decisions that favour

them rather than the company.

b) The combined role of chairman and C.E.O in my view gives him so much responsibilities

and may be a burden especially in decision making processes.

1.4 Financial markets & interaction with investors.

Air France-KLM is listed for trading in Paris (Euronext) and Amsterdam (Euronext). As all listed

companies are obliged to do, present and potential investors can easily find the company

published quarterly and annual financial reports as well as current stock information on their

investor relations website (www.airfranceklm-finance.com). In addition, Shareholders are also

invited to subscribe to the group’s financial send outs and news via email and mobile messages.

Furthermore, interested investors can inform themselves about the company’s business in press and market analytical researches.

The Shareholders’ Club also gives holders of at least 50 shares an exclusive link with the

company and access to all the company’s general and financial information, notably through the ACTION ‘air shareholders’ newsletter.

There also exists an Individual Shareholders’ Committee (ISC) which represents individual

shareholders to the Group’s management bodies. The Committee main aim is to communicate the

needs of individual shareholders, particularly in terms of financial communication, and pass on their questions, suggestions and requests.

1.5 Social obligations

The group has subdivided its corporate social responsibilities in the following categories

a) Environment

The company aims at reducing environmental footprint by improving its operations though

innovation of the supply chain and by mobilizing the entire staff and industry.

The company is investing in the use of biofuel-operated aircrafts as an alternative to fossil fuel.it

in fact operated the world’s first two commercial passenger flights using biofuels without any

changes to the aircrafts engines which is the first step to ensuring environmental sustainability.

Furthermore, the group supports environmental protection programs led by NGOs and also

supports efforts towards achieving a global climate agreement.

b) Customer experience

The company strive to integrating sustainability within the entire value chain in order to offer

customers sustainable and innovative products and services.

c) Responsible human resources

The company aims at maintaining a responsible social policy and encourage personal

development to ensure the motivation and professionalism of its employees. It seeks to uphold

gender equality and put in place measures that favour employment of disabled.

d) Local development

Aims at creating economic and social value at their hubs and destinations. In the recent past the

company has run

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1.6 Shareholders Breakdown

Number of issued shares at March 31, 2014

Number of shares issued 300,219,278

Number of theoretical voting rights 300,219,278

Number of exercisable voting rights 296,039,474

58,1%

17,6%

15,9%

7,0%1,4%

Institutional Individuals French state Employees Treasury stock

Breakdown of shareholding as of march 31, 2014

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2.0 FINANCIAL ANALYSIS

2.0.1 Air France-KLM Common-Size Balance Sheet

In € million 2013 2012

Goodwill 237 0,93% 252 0,94%

Intangible Assets 896 3,52% 842 3,15%

Flight Equipment 9391 36,94% 10048 37,60%

Other Property, Plant And Equipment 1819 7,15% 1932 7,23%

Investments in Equity Associates 177 0,70% 381 1,43%

Pension Assets 2454 9,65% 2477 9,27%

Other Financial Assets 1963 7,72% 1665 6,23%

Deferred Tax Assets 436 1,71% 1392 5,21%

Other Non-Current Assets 113 0,44% 152 0,57%

TOTAL NON-CURRENT ASSETS 17486 68,78% 19141 71,64%

Assets Held For Sale 91 0,36% 7 0,03%

Other Short-Term Financial Assets 1031 4,06% 933 3,49%

Inventories 511 2,01% 521 1,95%

Trade Accounts Receivables 1775 6,98% 1859 6,96%

Income Tax Receivables 23 0,09% 11 0,04%

Other Current Assets 822 3,23% 828 3,10%

Cash And Cash Equivalents 3684 14,49% 3420 12,80%

TOTAL CURRENT ASSETS 7937 31,22% 7579 28,36%

TOTAL ASSETS 25423 100% 26720 100%

LIABILITIES AND EQUITY

Issued Capital 300 1,18% 300 1,12%

Additional Paid-In Capital 2971 11,69% 2971 11,12%

Treasury Shares (85) -0,33% (85) -0,32%

Reserves And Retained Earnings (944) -3,71% 403 1,51%

Equity (Air France -KLM) 2242 8,82% 3589 13,43%

Non-Controlling Interests 48 0,19% 48 0,18%

TOTAL EQUITY 2290 9,01% 3637 13,61%

Provisions And Retirement Benefits 3102 12,20% 3158 11,82%

Long-Term Debt 8596 33,81% 9565 35,80%

Deferred Tax Liabilities 178 0,70% 149 0,56%

Other Non-Current Liabilities 397 1,56% 384 1,44%

TOTAL NON-CURRENT LIABILITIES 12273 48,28% 13256 49,61%

Liabilities Relating To Assets Held For Sale 58 0,23% - 0,00%

Provisions 670 2,64% 555 2,08%

Current Portion Of Long-Term Debt 2137 8,41% 1434 5,37%

Trade Accounts Payables 2369 9,32% 2219 8,30%

Deferred Revenue On Ticket Sales 2371 9,33% 2115 7,92%

Frequent Flyer Programs 755 2,97% 770 2,88%

Current Tax Liabilities 2 0,01% 3 0,01%

Other Current Liabilities 2332 9,17% 2474 9,26%

Bank Overdrafts 166 0,65% 257 0,96%

TOTAL CURRENT LIABILITIES 10860 42,72% 9827 36,78%

TOTAL LIABILITIES 23133 90,99% 23083 86,39%

TOTAL LIABILITIES AND EQUITY 25423 100% 26720 100%

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2.0.2 Air France –KLM Common-Size Income Statement

EUR millions 2013 % 2012 %

REVENUE 25520 100% 25420 100%

Cost of Goods Sold 2348 92,01% 2393 94,14%

Amortization Expense 80 0,31% 70 0,28%

Depreciation 149 5,84% 151 5,94%

Amortization of Intangibles 80 0,31% 67 0,26%

GROSS INCOME 470 1,84% (86) -0,34%

Other Operating Expense 340 1,33% 339 1,33%

Unusual Expense 241 0,94% 320 1,26%

EBIT( after Unusual Expense) (241) -0,94% (320) -1,26%

Non-Operating Income/Expense (87) -0,34% 119 0,47%

Non-Operating Interest Income 26 0,10% 28 0,11%

Interest Expense 356 1,39% 342 1,35%

Gross Interest Expense 365 1,43% 356 1,40%

Interest Capitalized 9 0,04% 14 0,06%

PRETAX INCOME (528) -2,07% (940) -3,70%

Income Tax 957 3,75% 17 0,07%

Equity in Affiliates (211) -0,83% (66) -0,26%

Consolidated Net Income 1700 6,66% (1020) -4,01%

Minority Interest Expense 9 0,04% 5 0,02%

NET INCOME (1710) -6,70% (1030) -4,05%

Extra ordinaries & Discontinued Operations (122) -0,48% (197) -0,77%

Discontinued Operations (122) -0,48% (197) -0,77%

NET INCOME AFTER EXTRA ORDINARIES (1830) -7,17% (1230) -4,84%

Preferred Dividends 0 0,00% 0 0,00%

NET INCOME AVAILABLE TO COMMON (1710) -6,70% (1030) -4,05%

EPS (Basic) (6,17)

(4,14) Basic Shares Outstanding 296,04

295,87

EPS (Diluted) (6,17)

(4,14) Diluted Shares Outstanding 296,04

295,87

Note

Calculations of EBIT for the last two financial years are as shown in the Common-size income

statement above

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2.1 Net Working Capital

The working capital acts as an indicator of whether a company has enough short term assets to cover its short term debt

Formula 2013 2012

Current Assets - Current Liabilities

= - 2961 million

= - 2248 million

The negative numbers may be an indicator of serious financial problems the company is facing,

but on the hand it may also indicate managerial efficiency as most airline companies operate on upfront payments basis the significantly reduces short term liabilities.

2.2 Average tax rate

The average tax rate is average percentage a company has to pay from its taxable income

Formula 2013 2012

Total Taxes Owed

Total Income

=−957

2290= −𝟎. 𝟖𝟎

=−1225

3637= −𝟎. 𝟑𝟒

In case of losses, as in AIR-France KLM, the principle of tax carry forward permitted by the French

tax law was utilized. The taxes can be carried forward for an indefinite period, however, the amount

of the fiscal loss recoverable each year is set at 50% of the profit for the period beyond the first

million.

2.3. Return on Equity (ROE)

This is a measure of the returns on the money invested by the shareholders.

Formula 2013 2012

Net Income

Equity (Year Beginning)

=−1710

2290= −𝟎. 𝟕𝟓

=−1030

3637= −𝟎. 𝟐𝟖

The negative ROEs shown above as a reflection of the losses that the company incurred in the

respective years translating to no dividends payments.

2.4 Return on Assets (ROA)

ROA is a measure of how efficient company is in generating profits from its assets.

Formula 2013 2012

After Tax Operaring income

Average Total Assets

=−1710

7939= −𝟎, 𝟐𝟏

=−1030

7579= −𝟎, 𝟏𝟒

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2.5 Return on Capital

Formula 2013 2012

After Tax operating Income

Average Total Capitalisation

−1460.8

2290= −𝟎. 𝟔𝟑

−790.6

3637= 𝟎. 𝟐𝟏

2.6 Market Value Added and Market Book Ratio

The Market Value Added is the difference between the current market value of a firm and the

capital contributed by investors.

Market capitalisation = (Shares Outstanding * share price) – Equity Book Value

= (300,219,278 * € 9, 60) – 2,290,000,000

= 592,105,068.8

Market Book Ratio = Market price per stock / Book value per stock

= 9.6/7.62

= 1.26

The book-to-market ratio attempts to identify undervalued or overvalued securities by taking the book

value and dividing it by market value. Since the ratio is above 1 the stock is undervalued

2.7 EFFICIENCY RATIOS

The ratios reflect how efficient a company is in using its assets.

2.7.1 Asset Turnover Ratio

Formula Air France-Klm Average Airline

industry

Revenue

Average Total Assets

=𝟐𝟓𝟓𝟑𝟎

(24423+26720)/2 = 1

0,89

For Air France KLM, each Euro of assets produced €1 of Revenue which slightly higher as compared

to the average Airline industry ratio of 0, 89 € meaning that the company had better mechanisms of

generating revenues from its assets.

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2.7.2 Receivables Turnover

The ratio measures the firms’ sales in proportion of its receivables.

Formula Air France-Klm Average Airline

industry

Revenue

Average Receivables

=𝟐𝟓𝟓𝟑𝟎

(2072+2200)/2 = 11.95

48,81

2.7.3 Average collection Period

This measures the speed with which customers pay their bills. It expresses accounts receivable in

terms of daily revenue

Formula Air France-Klm Average Airline

industry

Average Receivables

Sales/365

=(2072+2200)/2

25530/365 = 30.53

22,47

As compared to the Airline industry collection period of about 23 days, Air France KLM customers

pay their bills at a lower rate of about 31 days which means the company credit policies are a little bit

lenient in collection of bills from clients or the bill collection mechanism is marginally inefficient.

Generally, the industry has the highest average collection period ratio within the transport industry due to the fact that most the clients pay for flights in advance

2.8 Profitability Ratios

The ratios are financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time.

2.8.1 Profit Margin

Formula Air France-Klm

Net Income

Sales

=−1827

25530 = - 0.07 or (-7%)

The company has a net loss of € 0.07 for each euro of revenue.

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2.8.2 Operating profit margin

Formula Air France-Klm

Net Income + after tax interest

Sales

=−1827+−186

25530 = - 0.08 (-8%)

2.9 LEVERAGE RATIOS The ratios measure the financial leverage of a company which is the degree to which a company uses

fixed-income securities such as debt and preferred equity. The more debt a company uses, the higher

its financial leverage. A higher financial leverage means high interest payments, which negatively affect the company’s bottom –line earnings per share.

2.9.1 Long-Term Debt Ratio

Formula 2013 2012

Long Term Debt

Long Term Debt + Equity

=4913

4913 + 2290= 𝟎, 𝟔𝟖

=5839

5839 + 3637= 𝟎, 𝟔𝟐

In 2013 68 cents of every euro of long-term capital is in form of a long-term debt this translates to a

company heavily financed

2.9.2 Long-Term Debt Equity Ratio

Formula 2013 2012

Long Term Debt

Equity

=4913

2290= 𝟐, 𝟏𝟓

=5839

3637= 𝟏, 𝟔𝟏

2.9.3 Total Debt ratio

Formula 2013 2012

Total liabilities

Total assets

=23780

25423= 𝟎, 𝟗𝟒(𝟗𝟒%)

=23719

26720= 𝟎, 𝟖𝟗 (89%)

The company was heavily indebted in the years 2012 and 2013, on average 92% was financed with

debt, both long-term and short-term, compared to 8% Equity finance.

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2.9.4 Times Interest Earned

Acts as a measure of the extent to which a company interest obligations are covered by earnings.

Formula 2013 2012

EBIT

Interest Payments

=149

356= 𝟎, 𝟒𝟐

=−414

342= −𝟏, 𝟐𝟏

Cash Coverage Ratio

Formula 2013 2012

EBIT + Depreciation

Interest Payments

=23780

25423= 𝟎, 𝟗𝟒

=23719

26720= 𝟎, 𝟖𝟗

2.10 DU-Point System

ROA =Sales

Assets∗

Net income + interest

sales

ROA =2552

25423∗

−1710+356

2552= -0.1

ROE =Assets

Equity∗

Sales

Assets ∗

Net income + interest

sales∗

Net Income

Net income + Interest

ROE =25423

2290∗

2552

25423 ∗

−1710 + 356

2552∗

−1710

−1710 + 356= −𝟎. 𝟕𝟒

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3.1 Risk profile The risks exposed to Air France-Klm are the same risks associated to air transport and running a business. Some of the risks are analysed below

3.1.1 Competition

The average annual growth ofworldairtravelhasbeen roughly5% over the last 30 years which is

almosttwicetheannualgrowthof the global economy. The 1997 liberalization of the European

markets has been a fundamental factor to the cutthroat completion that besieges the airline industry not

only from within the airline industry but also from the general transport industry. Emergence of new completely priced airlines e.g. Easy jet and railway companies has that are Passenger growth as

shown in the table has not been strong New entrants of firm’s thus increasing horizontal competition

and also vertical completion to the industry the going

3.1.2 Jet fuel risks The Airline industry is heavily reliant on fuel prices. Any unforeseen changes in prices as in 2008 and 2011(as shown in table) drastically dent their short-term profitability and deter general operation. Most

airline companies mitigate this risk by use of use of fuel hedge strategies. These are contractual tools

that use swaps and options to reduce the exposure to volatile price fluctuations.

Therefore, companies gain planning

confidence especially for budgeting

purposes as well as give them ample time to adapt to the changing market conditions.

Air France –KLM fuel hedge framework sets the time span of the hedges to 2 years

(a rolling 24 months) with a target hedge

ratio of 60%.

As at December 30th 2013 the company

fuel exposure based on futures prices at December 27th 2013 ($109, 30 a barrel for

2014 and $102, 95 a barrel for 2015) was

as follows

In US$ million 2014 2015

Gross expenditure before hedging 9427 8906

Hedge percentage 60% 23%

Gain on hedging 223 26

Net expenditure 9204 8880

Based on the forward curve at December 27, 2013, an increase of $10 per barrel over 2014 would give

an average price of $119.30 per barrel and would lead to a $370 million increase in the fuel bill after hedging, i.e. a total fuel bill of $9.57 billion in 2014 for the Air France-KLM Group. Symmetrically, a

fall of $10 per barrel over 2014 would give an average price of $99.30 per barrel and would lead to a

$640 million reduction in the fuel bill after hedging, i.e. a total expense of $8.56 billion.

3.1.3 Foreign currency risk Currency volatility is a major issue for the airlines and particularly for the European carriers whose

costs are, for the most part, linked to the US dollar while their revenues are sensitive to all currencies.

Any depreciation in the euro relative to all currencies makes them more competitive at commercial

level. On the other hand, a fall in the euro relative to the dollar alone has a negative impact on costs.

Any appreciation in the euro relative to all currencies or only the dollar has the inverse effects. The

hedging strategies put in place by the airline with the aim of reducing the effects of currency volatility

73,3

99

61,5

79,4

111,

1

111,

8

0

20

40

60

80

100

120

2007 2008 2008 2010 2011 2012

Pri

ce($

)

Years

Oil Price/Barrel

Page | 15

3.1.4 Other Risks

Other risks that face the company includes;

GovernmentRegulations

Weather

Terrorism

Geopolitical instability

4.0 Stock Performance profile The stock gained 8.4 percent in 2013, trailing smaller competitor International Consolidated Airlines

Group SA (IAG), whose stock price more than doubled. It was the worst performer on Paris' broad

SBF 120 index. Generally, SBF120 fell by 52 %-- almost twice as much as German rival Lufthansa

(LHAG.DE) and underperforming International Airlines Group (ICAG.L). The drop shrunk the airline's market capitalisation to around 2 billion euros as it posted a 1.3 billion euro operating loss

quite comfortably the weakest financial performance of any European airline. High expenses on staff

costs of about a third of its revenue as compares with about a quarter for Lufthansa and IAG and a large debt pile of about 8 billion euros as compared to 1.4 billion of Lufthansa and tough competition

that have battered its shares.

Implementation of meaningful more aggressive instead of focusing on a multi-year strategies is

certainly needed on the cost side given an unreliable revenue environment. The management is trying

to adopt some measures to improve its competiveness with a plan to offer medium-haul flights from

regional bases in France in an effort to reduce operating costs by 15 percent.

The highest stock price was in March 31 2014 (€11.95) and also picked up on June 1 2014 when

Alitalia some positive developments from Etihad airlines for the purchase of to buy 49% which Air France Klm has a 7% stake closing at €10.72

Page | 16

Its competitors are In the similar scenarios as shown in the graph below that compares Air

France –KLm to Lufthansa.

Air France –Klm Vs Lufthansa

5.0 COST OF CAPITAL

Beta = 1.56

Risk free rate (France) = 5.0 %

Mature Market Expected Risk Premium (Damodaran as of 1 Jan. 2014) = 5%

𝑘𝐸 = 𝑅𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒 + 𝑏𝑒𝑡𝑎 ∗ 𝑚𝑎𝑟𝑘𝑒𝑡 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚

𝐾𝑒 = 5.0 + 1.56 ∗ 5 = 𝟏𝟐. 𝟖

𝐾𝑑 = (5.0 + 0,5) ∗ (1 − 0) = 𝟓. 𝟓

𝑊ACC = Ke ∗E

D + E + Kd

D

D + E

WACC = 12.8 ∗2290

12273 + 2290 + 5.5 ∗

12273

12273 + 2290

= 6.65

Page | 17

5.1 Optimal debt ratio

Cost of capital approach is used to determine the company optimal debt. The cost of capital is the cost of funds used for financing a business. Cost of capital depends on the mode of financing used – it

refers to the cost of equity if the business is financed exclusively through equity or to the cost of debt

if it is financed solely through debt. Another component of financing can be preferred stock. It will

also depend on the cost of each component.

Many companies use a combination of debt and equity to finance their businesses, and for such

companies, their overall cost of capital is derived from a weighted average of all capital sources, widely known as the weighted average cost of capital (WACC).

If the cash flows to the firm are held constant and the cost of capital is minimized then the value of the firm will be maximized. Therefore the value of a firm is represented as the present value of cash flows

to the firm, discounted back at the cost of capital.

The company is having a debt ratio at about 90%. According to the Cost of capital approach it would

be better to have a debt ratio at about 40%.

6.0 PROJECTS

6.0.1 Current project

The airline planning to is offer low-cost operative flights, a market where the airline has lagged behind

its competitors. The company will offer such services though Transavia airline, a subsequent sister

airline, and this will allow the airline increase its footprint in fastest growing European market.

Air France-KLM is also running a comprehensive transformation project, "Transform 2015" with the

aim of regaining competitiveness and repositioning its products and services at the highest international level. To refocus the airline on the customer and to regain economic independence,

Transform 2015 is based on an industrial plan reflecting this ambition in all areas of activity, on

actions to transform organization and management methods and to reconsider social agreements, while ensuring two fundamentals: flight safety and work safety. To ensure the sustainability of the airline

and ensure continued investment for customers, a return to breakeven is essential for Air France in

2014. The measures implemented to achieve this aim both to reduce costs, increase efficiency and to

enter a new phase of improved revenue, to better meet customer expectation.

The company is also investing 700 million euros in new cabins to stay competitive.

6.0.2 Typical project

Since the company is immensely emerged in debt, a transformation comprehensive project should be

launched with the aim of identifying propels to managing the debt. Serious transformational ideologies

should be implemented so as the airline can regain its way back to profitability.

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7.0 Financing

7.1 Debt The company capital structure is comprised of approximately 90% debt of about 10 billion euros.

Most of its debt is inform of bonds offered as shown in the table below.

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Debt type and maturity profile

At December 31, 2012, 32% of the current and non-current financial debt is made of bonds:

Bonds Amount in €

Perpetual subordinated bond 251

Perpetual subordinated bond 357

2020 convertible bond 420

2015 convertible bond 661

2014 bond 750

2016 bond 700

2018 bond 500

Advantages and disadvantages of using debt financing

Debt financing has definitely had positive and negative features. Companies face trade-off for opting

debt over equity as the cost of debt becomes a financial liabilities and potential bankruptcy risk. As for

the positive features, using debt sets some pressure on management for securing positive cash flows,

which could be a good practice for firms mainly financed by equity and/or not having a major

shareholder to put pressure on the management. There is a higher importance in picking stable and

profitable projects to cover for the future interest payments and to keep their job. In general, using debt

helps to keep profits within a company and increases returns on equity for current company owners

helps secure tax savings

7.2 Equity financing

Equity comprises of 10% of the company capital structure. This is mainly from offering

shares on the stock exchange. Composition of its shares is as discussed previously on the

financial structure.