Southwest Airlines

Southwest Airlines WACC and Capital Structure Analysis Luke Wil iams Adam Ly L le

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Southwest’s Investment • Purchase new airplanes from Boeing • The buying of additional planes is an excel ent investment because Southwest is expanding its existing operations through adding new destinations as wel as increasing their total flights • Southwest has a total of $9,876,000 in Assets and we are going to invest 25% or $2,469,000 for the purchase • We are using equity to finance

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The Required Rate of Return • The recommended required rate of return is 11.25% • We determined the required rate of return for equity through the SML approach • Beta for southwest was 0.9173• Since the proposed investment is expansion of existing operations we kept beta the same • The investment is one of moderate risk

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Adjusted EPS and ROE • The use of equity causes earnings per share to jump from $0.57 to $0.66, an increase of 17% • This is the same change in EPS as if debt financing was chosen so there was no to using debt • The ROE dropped from an old ROE of 9% to a new ROE of 8% • The drop is due to the issue of 158 new shares which increased the Market Capitalization to $12,162 • The increase in total equity is what decreases the new ROE

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WACC and the Capital Structure • The weighted average cost of capital increased from 10.44% to 10.65% through using equity • This increase not good, however, it was chosen through looking at the debt-equity ratios of debt and equity financing • The capital structure changed by only 2% in either direction using Equity so southwest is familiar with it • Using debt the capital stricture changes by over 10%

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Other Factors Influencing Using Equity • The volatility of the industries oil, labor, and insurance costs • Competitors are feeling the effects of high levels of debt of reduced cash flows • The industry trend in bankruptcy• Assets aren’t easily transferred

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