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Abstract：According to the ratio and index from applied corporate finance， the essay selects six listed companies in the airline industry and uses the data from 2013-2016 to do the analysis. Based on the different features for those companies， like size， ownership structure， life cycle， the essay calculates the variety ratios of each company. And the essay also provides the potential implications for their financial decisions and investment decisions to maximize the value of the company.
Key words： Financial leverage D/E ratio； Industry average leverage ratio；Tax Deductibility of interest； debt； cost of capital
1. Industry and Companies Choosing
We choose the Airline industry and the selected companies come from the USA and the UK.
Alaska Airlines： the tenth largest U.S. airline （market cap $9950m， large size）
JetBlue Airways： An American low-cost airline and the 6-th largest in the united states
（market cap $6410 medium size）
Delta Air Lines： one of the world's largest airlines （market cap $33450， large size）
EasyJet plc： the biggest airline company in the U.K （market cap $4960， medium size）
British Airways： one of the biggest players in the world （market cap $1257， small size）
Virgin Atlantic Airways： Virgin Atlantic now serves over 30 fabulous destinations worldwide （market cap $228， small size）
2. Firm-levelRatios & Industry Average Leverage Ratio
（1）Financial leverage - D/E ratio
Alaska Air Group
（2）Industry average leverage ratio
3. Company Cost of Capital
We compute cost of capital by the same method andchoose VVA as an example to show the detail of estimate：
（1）Current cost of capital
·Cost of equity
Risk free rate： United Kingdom Bond 15 Year Yield 1.30% （Market Risk Premium， 2017）
Market risk premium： 5 years’ historical average of United Kingdom total equity premium is estimated as 5.88%.
Beta： 1.05 （Market Watch， 2017）
Re=Rf+βeRM-Rf=1.30%+1.05×5.88%=7.474%
·Cost of debt
NetInterestCoverageRatio=EBITNetInterestExpense=41.3M8，608，320=4.80
According to Interest Coverage Ratios & Spread， for I/C ratio 4.80， VAA is rated as A2/A with current leverage. Spread is 1%.
CostofDebtRd=Rf+Spread=1.30%+1%=2.30%
·Current cost of capital （WACC）
WACC=EE+D×Re+DE+D×Rd×1-Tc=288M288M+175.6M×7.474%+175.6M288M+175.6M×2.30%×1-0.2=5.34%
All companies current cost of capital estimate information as below： The USA：Rf= 2.37%， MRP = 3.91%
The UK： Rf= 1.3%， MRP= 5.88%
（2）Optimal capital structure
We chooseVVA as an example to show the detail of estimate：
βUnlevered=βLevered1+DE×1-Tc=1.051+0.61×0.8=0.7056
βLevered=βUnlevered×1+DE×1-Tc=0.7056×1+DE×0.8
Re=Rf+βLeverd×MRP
Virgin Atlantics Airways： Cost of equity estimation
According to the summary of the optimal capital structure， the corporation from the USA （Alaska Air Group， JetBlue and Delta） are suggested a very high debt ratio， which is 90%， 80% and 80% respectively. However， all of these 3 companies’ debt ratio is very low. The net debt of Alaska Air Group is negative between 2013 to 2015 and JetBlue and Delta’s net debt are also very low compared with their large market cap in 2016. Therefore， these corporations from American have too little debt compared to the optimal capital structure and they should increase their debt to obtain the lowest cost of capital（4.58%， 3.26%， 6.65%） Moreover， the EasyJet and British Airways which come from UK have the similar capital structure with the American’s three company. The net debt of these company is 42milliion and negative 2652m in 2016. However， the optimal capital structure is 60% and 50% with the WACC 1.69 and 4.8 respectively. As a consequence， both these two company should increase its debt， especially the British Airways. The Virgin Atlantics Airways has the similar capital structure between the current and the optimal. If this can obtain a lower cost of capital （5.28%）， it should decrease its debt in some extent.
4. Potential Implication
Base on the marginal tax rate between the US （40%） and UK （20%）， the American corporation should increase its debt as soon as possible because they can enjoy a higher tax shield benefit compared to UK. For example， the Alaska airline which located in the US with the tax 40% enjoy 12-million-dollar tax deduction. However， if the Alaska airline execute the UK government’s tax policy （20%）， it would only have 6-million-dollar tax deduction. Therefore， it seems like the different of tax rate between two countries encourage the American companies to borrow more money. The optimal capital structure assumption calculated above also show that the American company are suggested to increase debt.
The economic and political environment of a country will affect the capital structure in this country. When the economic and political environment of a country is not stable， the currency will inevitably fluctuate. Take an example of the UK. Withdrawal of the United Kingdom from the European Union cause pound’s decline. The company of the UK will reduce to hold financial asset and increase the debt， because they will pay less interest. Reference：
[1 ]JetBlue Airways Corporation 2017， JetBlue’s 2016 Annual Report on Form 10-K， JetBlue Airways Corporation， viewed 12 October 2017，.
[2 ]Market Risk Premia 2017， Implied Market-risk-premia （IMRP）： United Kingdom， Market Risk Premia， viewed 12 October 2017， < http：//www.market-risk-premia.com/gb.html>.
[3 ]MarketWatch 2017， Annual Financials for Alaska Air Group Inc.， MarketWatch， viewed 08 October 2017， < http：//www.marketwatch.com/investing/stock/alk/financials/balance-sheet >.
[4 ]MarketWatch 2017， VM. Stock Price - Virgin Money Holdings （UK）PLC Stock Quote （U.K.： London）， MarketWatch， viewed 12 October 2017， < http：//www.marketwatch.com/investing/stock/vm.？countrycode=uk>.
[5 ]The Wall Street Journal 2017， DAL Financial Statements - Delta Air Lines Inc， The Wall Street Journal， viewed 12 October 2017， < http：//quotes.wsj.com/DAL/financials>.
[6 ]Virgin Atlantic Airways 2017， Virgin Atlantic Airways’ 2016 Annual Report， Virgin Atlantic Airways， viewed 12 October 2017， < https：//www.virginatlantic.com/content/dam/vaa/documents/footer/mediacentre/VAL_FY16_Annual_Report.pdf >.
[7 ]Yahoo！ Finance 2017， DAL Key Statistics - Delta Air Lines Inc. Financial Ratios， Yahoo！ Finance， viewed 12 October 2017， < https：//finance.yahoo.com/quote/DAL/>.
[8 ]Yahoo！ Finance 2017， IAG.L Key Statistics – International Consolidated Airlines Group， S.A. Financial Ratios， Yahoo！ Finance， viewed 12 October 2017， < https：//finance.yahoo.com/quote/IAG.L？p=IAG.L. >.
Author profile：
Liujie Lu，The Australian National University.
Key words： Financial leverage D/E ratio； Industry average leverage ratio；Tax Deductibility of interest； debt； cost of capital
1. Industry and Companies Choosing
We choose the Airline industry and the selected companies come from the USA and the UK.
Alaska Airlines： the tenth largest U.S. airline （market cap $9950m， large size）
JetBlue Airways： An American low-cost airline and the 6-th largest in the united states
（market cap $6410 medium size）
Delta Air Lines： one of the world's largest airlines （market cap $33450， large size）
EasyJet plc： the biggest airline company in the U.K （market cap $4960， medium size）
British Airways： one of the biggest players in the world （market cap $1257， small size）
Virgin Atlantic Airways： Virgin Atlantic now serves over 30 fabulous destinations worldwide （market cap $228， small size）
2. Firm-levelRatios & Industry Average Leverage Ratio
（1）Financial leverage - D/E ratio
Alaska Air Group
（2）Industry average leverage ratio
3. Company Cost of Capital
We compute cost of capital by the same method andchoose VVA as an example to show the detail of estimate：
（1）Current cost of capital
·Cost of equity
Risk free rate： United Kingdom Bond 15 Year Yield 1.30% （Market Risk Premium， 2017）
Market risk premium： 5 years’ historical average of United Kingdom total equity premium is estimated as 5.88%.
Beta： 1.05 （Market Watch， 2017）
Re=Rf+βeRM-Rf=1.30%+1.05×5.88%=7.474%
·Cost of debt
NetInterestCoverageRatio=EBITNetInterestExpense=41.3M8，608，320=4.80
According to Interest Coverage Ratios & Spread， for I/C ratio 4.80， VAA is rated as A2/A with current leverage. Spread is 1%.
CostofDebtRd=Rf+Spread=1.30%+1%=2.30%
·Current cost of capital （WACC）
WACC=EE+D×Re+DE+D×Rd×1-Tc=288M288M+175.6M×7.474%+175.6M288M+175.6M×2.30%×1-0.2=5.34%
All companies current cost of capital estimate information as below： The USA：Rf= 2.37%， MRP = 3.91%
The UK： Rf= 1.3%， MRP= 5.88%
（2）Optimal capital structure
We chooseVVA as an example to show the detail of estimate：
βUnlevered=βLevered1+DE×1-Tc=1.051+0.61×0.8=0.7056
βLevered=βUnlevered×1+DE×1-Tc=0.7056×1+DE×0.8
Re=Rf+βLeverd×MRP
Virgin Atlantics Airways： Cost of equity estimation
According to the summary of the optimal capital structure， the corporation from the USA （Alaska Air Group， JetBlue and Delta） are suggested a very high debt ratio， which is 90%， 80% and 80% respectively. However， all of these 3 companies’ debt ratio is very low. The net debt of Alaska Air Group is negative between 2013 to 2015 and JetBlue and Delta’s net debt are also very low compared with their large market cap in 2016. Therefore， these corporations from American have too little debt compared to the optimal capital structure and they should increase their debt to obtain the lowest cost of capital（4.58%， 3.26%， 6.65%） Moreover， the EasyJet and British Airways which come from UK have the similar capital structure with the American’s three company. The net debt of these company is 42milliion and negative 2652m in 2016. However， the optimal capital structure is 60% and 50% with the WACC 1.69 and 4.8 respectively. As a consequence， both these two company should increase its debt， especially the British Airways. The Virgin Atlantics Airways has the similar capital structure between the current and the optimal. If this can obtain a lower cost of capital （5.28%）， it should decrease its debt in some extent.
4. Potential Implication
Base on the marginal tax rate between the US （40%） and UK （20%）， the American corporation should increase its debt as soon as possible because they can enjoy a higher tax shield benefit compared to UK. For example， the Alaska airline which located in the US with the tax 40% enjoy 12-million-dollar tax deduction. However， if the Alaska airline execute the UK government’s tax policy （20%）， it would only have 6-million-dollar tax deduction. Therefore， it seems like the different of tax rate between two countries encourage the American companies to borrow more money. The optimal capital structure assumption calculated above also show that the American company are suggested to increase debt.
The economic and political environment of a country will affect the capital structure in this country. When the economic and political environment of a country is not stable， the currency will inevitably fluctuate. Take an example of the UK. Withdrawal of the United Kingdom from the European Union cause pound’s decline. The company of the UK will reduce to hold financial asset and increase the debt， because they will pay less interest. Reference：
[1 ]JetBlue Airways Corporation 2017， JetBlue’s 2016 Annual Report on Form 10-K， JetBlue Airways Corporation， viewed 12 October 2017，
[2 ]Market Risk Premia 2017， Implied Market-risk-premia （IMRP）： United Kingdom， Market Risk Premia， viewed 12 October 2017， < http：//www.market-risk-premia.com/gb.html>.
[3 ]MarketWatch 2017， Annual Financials for Alaska Air Group Inc.， MarketWatch， viewed 08 October 2017， < http：//www.marketwatch.com/investing/stock/alk/financials/balance-sheet >.
[4 ]MarketWatch 2017， VM. Stock Price - Virgin Money Holdings （UK）PLC Stock Quote （U.K.： London）， MarketWatch， viewed 12 October 2017， < http：//www.marketwatch.com/investing/stock/vm.？countrycode=uk>.
[5 ]The Wall Street Journal 2017， DAL Financial Statements - Delta Air Lines Inc， The Wall Street Journal， viewed 12 October 2017， < http：//quotes.wsj.com/DAL/financials>.
[6 ]Virgin Atlantic Airways 2017， Virgin Atlantic Airways’ 2016 Annual Report， Virgin Atlantic Airways， viewed 12 October 2017， < https：//www.virginatlantic.com/content/dam/vaa/documents/footer/mediacentre/VAL_FY16_Annual_Report.pdf >.
[7 ]Yahoo！ Finance 2017， DAL Key Statistics - Delta Air Lines Inc. Financial Ratios， Yahoo！ Finance， viewed 12 October 2017， < https：//finance.yahoo.com/quote/DAL/>.
[8 ]Yahoo！ Finance 2017， IAG.L Key Statistics – International Consolidated Airlines Group， S.A. Financial Ratios， Yahoo！ Finance， viewed 12 October 2017， < https：//finance.yahoo.com/quote/IAG.L？p=IAG.L. >.
Author profile：
Liujie Lu，The Australian National University.