Aiding Barra Airways With ROCE

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Equity investors will look at the ROCE in order to determine if a firm is effectively deploying its capital. Having a ROCE that is in-line with its competitors will aid Barra Airways in achieving a good price for its equity, should it choose to use equity as a source of finance. Barra Airways has an interest coverage ratio (ICR) of 18; this means that Barra Airways is not burdened with a large amount of interest payments on existing debts. Therefore, using debt does appear to be an attractive source of finance. This is because Barra Airways existing interest burden is low, meaning that to increase it would have a reduced effect on the company’s net profit. However, EasyJet has an ICR of 30.88, considerably larger than that of Barra Airways [5]. Lenders may look at this data and conclude that Barra Airways is a riskier company to lend too than others in the same industry; this will result in a higher interest rate on any debt taken out. In order to reach a decision on which method of raising finance would be appropriate for Barra Airlines an analysis of the benefits and drawbacks of both the debt and equity method must be undertaken. Using equity as a source of finance would mean that Barra Airways would be increasing the level of shareholder accountability it currently has. In the future, Barra Airways may find that in the future its freedom to make conduct business freely is hindered, if it issues more equity. The legal action taken by shareholders against companies has risen substantially since 1996 [7]. If this trend continues into the future then the likelihood of Barra Airways experiencing shareholder activism is significant. A key benefit of equity financing is that the company will not be debt repayments. This is beneficial... ... middle of paper ... ... Airways with the burden of increased repayments without the assistance of increased revenues. It is my recommendation that Barra Airways goes ahead with the project. I believe this is the case because the project is predicted to a high NPV coupled with strong cash flows. The method of financing I am recommending that Barra Airways uses is to issue more equity. This is primarily due to the confidence the market currently has in low-cost airlines. This will not only achieve the best value for the company but will also maximise the shareholder value of the project. The secondary reason behind the decision to use equity as the source of the projects finance is protecting the company against future debt repayments. If the cash flows prove to be unreliable then the company could find itself paying a higher than expected proportion of operating profit on paying its debts.

In this essay, the author

  • Explains that equity investors will look at the roce in order to determine if a firm is effectively deploying its capital.
  • Explains that barra airways has an interest coverage ratio of 18 and uses debt as a source of finance.
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