A 300 words evaluation of the recommendations for American airlines - Essay Example

Evaluation of Recommendations In order to evaluate first recommendation, we have chosen financial analysis strategy. The calculations of ROCE, payback period and discounted cash flow have made it easier for me to evaluate our first recommendation. To evaluate second recommendation, we have used cost benefit analysis. We have chosen this method because it could help us to evaluate benefits and costs incurred by company with or without hedging. To evaluate third recommendation, we have again chosen cost benefit analysis because this option could help us to understand benefits or costs associated with hiring or not hiring a consultant.

We have found that acquiring Jet Blue is a good strategic option for American Airlines because cost of the project is $787 whereas; discounted cash flow is $848. The payback period is only 2.76 years and after this period; American Airlines will cover its costs and will incur positive cash flows. Moreover, ROCE is 0.3830 which means that after acquiring Jet Blue, the company may earn significant return on its total capital employed. Second, American Airlines should give more focus on hedging fuel prices because if fuel prices increase, it will incur a profit of $836 million and if fuel prices decline then it may incur a loss of $836 million.

However, in consideration to previous fuel prices trend, a 10 percent increase in fuel prices is expected. Third, hiring a training company is a very good recommendation because company may improve its teamwork performance, crew coordinator, customer services and ultimately the revenues. Acquiring Jet Blue should be the first, hedging of fuel prices should be second and hiring a consultant should be third on priority list because company is already hedging prices and it needs to be get more aggressive in it and hiring a consultant does not incur that much efforts therefore, they are on second and third.

Bibliography American Airlines. (2009) Financial Statements. [Online] Available from: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MzgwNjA1fENoaWxkSUQ9Mzg0Nzc2fFR5cGU9MQ==&t=1[Accessed 24 May 2010].JetBlue Airways. (2005) Annual Report 2005. [Online] Available from: http://www.jetblue.com/about/ourcompany/annualreport/2005/mdna_lcr.html [Accessed 24 May 2010].Money Central. (2009) JetBlue Airways Financial Statements. [Online] Available from: http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=jblu&lstStatement=Balance&stmtView=Ann[Accessed 24 May 2010].

AppendixAppendix IBuying a low cost airline Jet BlueFinancial analysis 1) Return on Capital Employed = Operating income before interest and tax/Assets employed Return on Capital Employed for American Airlines = $11,974/$25,4381 = 0.4707Return on Capital Employed for Jet Blue = $279/$6,5542= 0.0426Combined Return on Capital Employed = ($11,974 + $279)/ ($25,438 + $6,554) = 0.3830The value shows that the overall ROCE will be 0.3830, which is although lesser than 0.4707, however, in the long run it is a very optimistic value. 2) Payback Period = cost of project / annual net revenue Payback Period = $787/285 = 2.

76Projected annual revenueYearNet RevenueTotal 2010155.44155.442011416.5792572.019220121116.4322561688.4513) Discounted Cash Flow DCF = $335/(1+0.09) + $335/(1+0.09)2 + $335/(1+0.09)3DCF = $848Assumptions: The operating revenue has been taken for Domestic American Airlines, however, the Assets employed value has been taken from consolidated balance sheet statement We have assumed that Net worth of JetBlue is 12 percent3 of its assets which means that if its assets in 2009 were $6554 million then its net worth is $787 million.

This will be the cost of the project for American Airlines. To project the net revenue, the growth rate of 1.68 has been used. It has been calculated by subtracting the net revenue of 2008 from net revenue of 2009 and dividing it by the net revenue of 2008. I have assumed that average revenue generate per year will be about $285 million, which has been calculated by (155+416)/2. For discounted cash flow, cost of capital has been assumed as 9 as according to annual report of 2009 of American Airlines the highest cost of capital it is incurring is 9 percent on long term bonds.

4 In 2009, the net cash flow of JetBlue was $335 million therefore; I am assuming the same cash flow in the coming years. Appendix II: Fuel prices hedgingIn this section, we have used cost-benefit analysis technique Expected gallons consumer in 20103370 gallons Cost incurred Benefit $mCost $mIf price per gallon is $2.48 and the market price is $2.728Incurred by company $8,357 Market = $9193= 9193 – 8357 = 836If price per gallon is $2.48 and the market price is $2.232Incurred by company $8,357 Market = $7521=$8,357 - $7521 = 836Assumptions:In 2008 and 2009 the cost of fuel has increased by 10 percent.

The current hedging fuel price of American Airlines is $2.48 per gallon (cap price) and $1.80 per gallon (floor price). 5 The total gallons consumed by American Airlines in 2009 are 2,762 million gallons and its cost is $5,553 million. The average fuel price per gallon in 2009 was $2.01.6The expected increase in fuels in terms of gallons is 22 percent which means that the expected increase in number of gallons will be 608 therefore, the expected number of gallons consumed in 2010 is 3370 gallons.

Appendix III: Hire a specialized consultantBenefitCosts If a consultant is hired Increase in teamwork practices Customers satisfaction $60,000If a consultant is not hired $60,000Poor crew performance because of lack of coordinationDeclining revenuesPoor customer experienceAssumption:If American Airline hires a training company to train its staff, I assume that total cost incurred will be $ 5000 per session and if total sessions in a year are 12 then total costs will be $60,000