CASE STUDY : STRATEGIC FINANCIAL PLANNING - AVION AIRLINES

CASE STUDY : STRATEGIC FINANCIAL PLANNING - AVION AIRLINES Avion airlines has been operating as an independent airlines for five years following a management buyout from a major airline. The airline operates a range of scheduled services in the UK and Europe. Avions profits to date have been marginal, but in the past 18 months there has been a sustained growth in passenger numbers on all the companys routes. This growth is expected to continue, and forecasts by various industry bodies have estimated that revenue-paying passenger growth, for the European industry in general, will continue at an average of 5-6 per cent per year for the next four years. The directors would like to capitalize on these trends and, following a strategic review of the business, they have prepared a three-year strategic growth plan for the company The key elements of the companys future strategy are : to develop what the directors believe to be under-served, European routes ; to seek strategic alliance agreements with other, selected major carriers in order to generate increased passenger volumes and to enhance the companys market profile; to continue to develop the capacity, quality and operating performance of its air fleet; to obtain a stock exchange listing within the next three years. The proceeds from any stock exchange flotation would be used to launch new routes and develop existing routes. The directors are currently finalising negotiations on new strategic alliance arrangements with several selected airlines to expand Avions route network. To date, no binding agreements have actually been signed, but Avion has begun to operate two new services for one major carrier. The directors strategic plan
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CASE STUDY : STRATEGIC FINANCIAL PLANNING - AVION AIRLINES

assumes that all alliance agreements being negotiated will become fully operational. Based on these arrangements, Avions scheduled services would be expected to grow by 20 per cent per year in year one, and by 25 per cent in years two and three. Charter services are forecast to increase by 10 per cent per year over the next three years. The directors are confident that current gross profit margins can be maintained on all planned service developments. The planned growth in services would require the company to fund leasing payments for two new, larger and more technologically advanced and efficient aircraft. The lease payments will gradually escalate from current levels over the three year period, by 30 per cent in year on e and by a further 20 per cent per year in years two and three, to reach the maximum annual rental payments of $ 1.03 million in year three. The growth plan assumes that other operating costs will behave as follows: Staff costs are expected to increase by 25 per cent in year one, a further 20 per cent in year two and an additional 10 percent in year three. Fuel costs are estimated at 5 per cent of total turnover. Fuel costs form a significant proportion of the companys total operating costs and the companys operating performance is regarded as being sensitive to changes in fuel costs. The strategic plan assumes that any increases in fuel prices can be recovered by increasing fares. Depreciation is estimated to increase by $0.01 million in year one and then remain unchanged for years two and three. Other costs are forecast to increase by 10 per cent per year. In general, Avions cost structures are characterised by high fixed costs, which do not vary significantly in relation to the number of passengers carried. Accordingly the companys profitability is regarded as being highly sensitive to the volume of fare-paying passengers carried, as even a relatively minor change in fare-paying
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CASE STUDY : STRATEGIC FINANCIAL PLANNING - AVION AIRLINES

passenger numbers can have a substantial impact on the companys financial performance. The directors have stated that any future earnings will be retained to fund business developments and that dividends will not be paid over the next three years, after which time this policy will be kept under review. The directors plan to spend $0.05 million per year on fixed assets and invest $0.01 million each year in net working capital. The companys fixed assets consist mainly of equipment and vehicles - it does not own any land or buildings. The companys profit and loss account and cash flow statement for the financial year just ended are as follows: Avion Airlines Profit and Loss Account for year ended 31 December $m Turnover Scheduled services Charter services Cost of sales Gross profit Operating costs: Staff Leasing rentals Fuel Depreciation Other Operating profit Taxation (25%) Profit after tax Dividends
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3.66 1.83 5.49 3.29 2.20 0.69 0.55 0.27 0.05 0.55 0.09 0.02 0.07 0.00

CASE STUDY : STRATEGIC FINANCIAL PLANNING - AVION AIRLINES

Retained profits Average number of shares (million) Avion Airlines Cash Flow Statement for year ended 31 December $m 0.09 0.05 0.14 0.00 0.00 0.02 0.12

0.07 0.5

Operating profit Depreciation Capital expenditure Net working capital Taxation Cash flow

Similar companies in the same industry as Avion have an average P/E ratio of 18. As an independent consultant you have been asked, based on the above information and making what other assumptions you consider reasonable, to review the directors strategic plan and to: a) prepare a forecast profit and loss account for each of the next three years; b) prepare a cash flow forecast for each of the next three years, assuming no time lag in tax payments; c) identify and briefly comment on the risk factors (economic, financial, industrial, competitive, regulatory, etc.) which you consider relevant to an appraisal of the companys strategy and which would merit further assessment. d) based on your analysis, comment on the suitability of the companys future strategy and objectives. State any other information, financial and nonfinancial which you think would assist your analysis. For convenience work in $m and round your figures to two decimal places.

Submission of Case study and quick discussion on September 20 file:///D|/Second%20attempt%202007/unit%204/Case%20Unit4.htm (4 of 5) [1/3/2007 4:25:48 PM]

CASE STUDY : STRATEGIC FINANCIAL PLANNING - AVION AIRLINES

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