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Mumbai Education Trust Asian Management Development Centre

Date of examination April 24, 2006


PGeMBA II 1st year Final Exam paper
Financial Management 1, case study module
Total Marks 100 ; Weightage 50%
Total time : 3 hours
Total Pages: 11

Instructions
1. Please read the instructions carefully before proceeding.
2. This paper consists of one case. Please provide the solution to the case.
3. Please read the entire case carefully before attempting the solution.
4. The solution must be provided in the form of a structured report. The
desired report format is given as an integral part of the case.
5. This is a closed book exam. You will need a scientific calculator for
calculations during the exam. Please arrange for the calculator before beginning
the paper. Please note that no exchange of calculators with other students
is allowed during the exam under any circumstances. Present value tables as
required for solving the case are provided with the paper.
6. Total marks 100.
7. Marking pattern :The marks distribution pattern is clearly explained in the case
itself and is based on the following principles:

Structured report of the solution 30%

The desired structure of the report along with the marking pattern for the report is
given in Annexure 1 of the case along with total marks assigned thereof. The report
should be crisp and precise and should not exceed 750 words.

Numerical analysis 70%

The body of the case poses various numerical problems. All the financial workings
should be presented as annexures to the report, clearly numbered with crossreferences in the main report. The brief findings from the financials only should be
presented in the report.
8. The exam aims to test your understanding of the subject.
I WISH YOU THE BEST OF LUCK

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Case study
Jeet Airways (JA)
Jeet Airways (JA) is the countrys premium airline operator with a fleet size of 50
aircrafts operating both in the domestic and international sectors.

While JA is

operating in the domestic sector since 10 years, it has recently entered the
international sector following regulatory changes. In the beginning of 2006, JA,
looking to consolidate its already strong position in the industry, was exploring
opportunities for growth, both in the domestic and international sectors.
The opportunities being explored specifically included:

Purchase of new aircrafts for international sector

Purchase of new aircrafts for domestic sector

In the investment committee meeting held in mid-March 2006, the business


managers for the two sectors presented their respective business cases, as under:
The international sector head, Mr. Sharma said, JA has only recently entered the
international travel segment. While the business is no doubt very competitive, as a
new entrant, we still have to make our presence felt on some very vital routes, which
will provide us a critical mass.

Currently, our international sector achieves a

passenger load factor of 75% and a cargo business of 5 metric tones (mt)/flight. We
need 2 additional aircrafts to establish our presence on the vital routes, which will
enable us to route our traffic in a more flexible manner. This will result in achieving a
higher passenger and cargo business of 80% & 7 mt/flight respectively, for the new
airplanes.
The international sector in the airline business has generally more competition and
therefore commands a lower fare per km. It also has a marginally higher in-flight or
operations costs.

However, there are 2 distinct advantages of the international

sector. Since the sectors flown are usually the busy sectors, this results in higher
average passenger load factor than domestic flights. Moreover, since flights operate
throughput day and night and with fewer stopovers, it operates more kms annually,
compared to the domestic sector with fewer take-offs. It has higher airport costs,
taxes and duties.
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Mr. Mohit, while making his case for the domestic sector informed the Board, In the
domestic segment, we are a well established player. Since we operate both on the
premium and feeder routes, our passenger load factor, on an average, is lower than
the international sector. However, our fares per km are higher. Please remember,
the local market is witnessing a revolution in air travel, which is growing rapidly. With
growing volumes, we need to have our presence on more routes. Our load factors
will also grow with time. However, I am not basing my current business case on
higher passenger Load Factos (PLFs). As per his estimates, JA had a demand for
5 new aircrafts to meet his near time growth plans.
Mr. Inamdar, the CFO explained JAs leveraging policy of a long term debt: equity
ratio of 1:1 and expressed doubts regarding JAs financial strength to order 7 new
aircrafts.
We need to recognize our financial limitations given the DER constraints and the
balance sheet position to arrive at our current spending capacity. Moreover, any
decision to add capital investments should be taken up within the accepted capital
budgeting processes and practices.

Currently, he said, we traditionally use a

combination of payback and IRR as capital budgeting methods, but given the large
scale of investment and its complexity, I am open to accepting the most scientific
technique for evaluating these investments (please justify the method you propose
for capital budgeting). Appendix 2 provides the financial highlights for JA.
Aircraft Choice
The business managers, then presented their financial case, the numbers are placed
at Appendix 3. The qualitative highlights and analysis are presented below:
In the international sector, JA is evaluating purchase of the 400 seat range aircrafts.
It is evaluating one of the two aircrafts:

Airbus A340

- 450 seater

Boeing 777

- 375 seater

The management is keen to evaluate which of the two aircraft to purchase, if any.

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In the domestic sector, JA is considering purchase of Boeing 737, a 175 seater


aircraft, if viable.
Revenue Model:
In the airline business, the revenues come through:
i) Passenger fares & (ii) cargo revenues. Each flight endeavours to carry some
cargo in the balance available weight.

The passenger load factor is the

capacity utilization.
The costs include:
(i) Fuel, (ii) maintenance, (iii) operations cost, (iv) manpower cost, (v) airport
taxes & charges & (vi) administrative costs.
The fuel and maintenance costs vary significantly from aircraft to aircraft. Moreover,
the costs are either per km, per flight or per year. International aircrafts cover more
kms but fewer flights per day. Their fares per km are lower but so are their fuel,
maintenance and service costs.

Their manpower, administration and taxes are

higher. The working capital consists of 1 month of receivables and 1 month of fuel
creditors and an inventory of spares equivalent to 1% of the aircraft capital cost.
At this juncture, after listening to all the details, Mr. Kumar, the CEO took charge of
the meeting.
We want to expand in the most profitable sectors. We are committed to spend all
the available funds in line with our corporate policy. Thus the options are clear.
(Can you help JA to draw-up the options tree and compute the available funds?).
While we can use opportunity cost of funds, (adjusted for inflation) for discounting
cash flows for the domestic sector, the international sector being more risky, we
should use a risk premium of 2% over the inflation adjusted opportunity cost.
(Please compute the applicable rates of discount).
Most importantly we want to decide on the mix of aircrafts to be purchased and their
quantities, which should be decided based on their economics. (Can you help Mr.
Kumar in making this decision?).
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The Board would like to see the financial report for the problem and the decision so
that we consider it for approval. (Please present this report). Please note that we
convene our Board meeting on 24th April06 at 6.30 p.m., so please present your
report before that. The guidelines for the submission are at Appendix 1.
@ copyright 2006. Vikram Sampat. No reproduction of this case in whole or any part hereof
can be made without the written permission from the author.
Notes:
1.

Some useful formulae & PV tables are provided at Appendix 4 & 5.

2.

Interest on loans 9% p.a.

3.

Corporate tax rate 30%

4.

Exchange rate Rs.45/US $

5.

Aircraft WDV depreciation rate 20%

6.

Long term inflation rate (projected) 4% p.a.

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Appendix 1
The Board of Directors set the following guidelines for the investment committees
final report and directed the following inclusions/ analysis/ explanations in the report.
The report should be crisp and precise and not exceeding 750 words (excluding
annexures), with cross-references for annexures.

30 marks

Report Structure
1. Objective
2. Problem definition and options analysis
3. Methodology with rationale
4. Brief financial results (findings of your calculations)
5. Conclusions and recommendations
6. ANNEXURES (Financials)
(as per break-up given below)

70 marks

1. Assumptions

(5 marks)

2. Determination of available funds for investments

(15 marks)

3. Determine suitable, adjusted discounting rates for


cases

(15 marks)

4. Cash flow for the investment decision

(25 marks)

5. Investment decision and funds allocation based on


cash flow, funds and discounting rate constraint

(10 marks)

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Appendix 2
Rs. in Millions

2001

2006

Sales

21000

60000

PBDIT

12700

30000

Deprecation

3000

7500

Interest

2000

7500

Tax

1500

4000

PAT

6200

11000

11700

No. of shares, millions

100

100

100

EPS, Rs.

62

110

117

DPS, Rs.

15

20

21

1060

Equity capital

1000

1000

Reserves & surplus

32000

75000

Long term loans**

40000

87000

Net fixed assets

67000

143000

Net current assets

5000

18000

Net investments*

1000

2000

Avg. share price

2007 Projected

7500

Only relevant information for 2007 projected is provided


*2006 Investments on the books can be liquidated to raise funds for expansion, at
market value of Rs.3500 million.
**Interest on current & future long term loans 9% p.a.

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Appendix 3
International

Domestic

A-340

777

737-400

Seating capacity

450

375

175

Aircraft cost, $ million

185

165

65

Flight kms/yr*, in million

1.5

1.5

1.0

No. of landing/yr

1050

1050

1400

PLF Year 1**

75%

80%

72%

Year 2

78%

83%

72%

Year 3 onwards

80%

86%

72%

Useful life, yrs.

Salvage value, Rs.cr.

80

60

25

Fuel cost, Rs./flight km

350

325

240

Operating cost, Rs./ASKM

0.3

0.3

0.15

Maintenance, % aircraft capex

3%

3%

3%

Manpower cost, Rs. million/yr

200

200

150

Administrative cost, Rs million /yr

100

100

100

50000

50000

15000

20%

20%

20%

Avg. Cargo carried, mt

3.5

Passenger fare Rs./km flown

Cargo fare Rs./mt/km flown

50

50

100

Airport Charges, Rs/landing


Depreciation rate,

*Flight Kms = No. of kms flown by the aircraft annually


ASKM = Available seat kms = no. of km flown by the aircraft x no. of seats available
**PLF (Passenger load factor) = Filled up seat km
AS Km
RPKMS = PLF x ASKM = Filled up seat km
Manpower cost will have an increment of @ 5% p.a.

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Appendix 4
Useful formulae/ concepts in Financial Management
1. Cost of Equity

Div1
P0

Ke =

+g

Where Ke = Cost of equity


Div1= Dividend for year 1
P0 = Average share price for year 0
g = growth in profits
2. Cost of capital weighted average of cost of equity and cost of debt
3. AEV = NPV/PVAF (no. of years, discounting rate)
4. Popular methods of capital budgeting
Payback method
NPV Net present value method
IRR Internal Rate of Return method
PI Profitability index method
5. Profitability Index =

NPV
Capex

+1

6. Real rate (k) = (1 + nominal rate) - 1


(1 + inflation rate)
7. Useful formula for present value calculations in case of constant cash flows at
constant intervals.

NPV =

FT x (1 - rn)
(1 - r)

Where FT = First term


r = Constant multiplier
n = Number of periods
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Appendix 5

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