Capital Structure Analysis: British Airways Case Study


Capital structure is one of the basic notions used in the world of business, as far as this structure determines, to a great extent, the market position of a certain company, as well as its attractiveness to partners and investors (Grossman, 2009, p. 129). In every industry, companies have peculiar ways of forming and modifying their capital structures, and the focus of the current paper is the airline, or aviation, industry, represented by one of the world’s aviation leaders, the British Airways. The annual reports of this company display rather controversial figures in the areas of equity, debt, and WACC (British Airways, 2007; 2008; 2009), and this fact serves as the major reason for the further presented analysis of the capital structure of British Airways. In particular, the company’s capital structure dynamics is analyzed with the help debt and equity and gearing ratios and examined through major capital structures theories accessible at the moment.

Basic Capital Structure Theories

On the whole, the ideas about capital structure rest on four major pillars, i. e. four most influential theories that scholars have produced over the time of their work in this area of knowledge. The milestone theory of capital structure was formed by Modigliani and Miller in 1958 (Brigham, 2007, p. 442). According to this theory, if the conditions of the market are ideal, the capital structure has no effect on the overall value of the company, as both these phenomena are perceived as different and independent business notions. However, this theory is criticized by many scholars, including Brigham (2007) and Grossman (2009) for its being impossible in practice, as far as Modigliani and Miller consider the irrelevance of capital structure under the conditions of there being no taxes and agency costs, firms not using debts to fund their operations, while investors possessing similar information as the management of the firm about the latter’s developmental potential (Brigham, 2007, p. 442).

Obviously, such conditions are impossible in practice, but still the ideas by Modigliani and Miller were used by scholars to develop opposite theories on its basis, drawing from the assumption that if in the ideal market the capital structure has no value, in the real business world it does have considerable significance. Based on this idea, Brigham (2007) and Grossman (2009) argue about three major theories dominating the capital structure studies today, i. e. the trade-off, the pecking order, and the agency costs theories. The trade-off theory originated by Kraus and Litzenberger defends the relevance of bankruptcy costs and financing of a firm with the help of debt (Grossman, 2009, p. 151), while the pecking order theory by Myers and Majluf sees the lest effort principle as the basis for capital structure development by which equity is preferred during internal funding and debt is used with external funding processes (Grossman, 2009, p. 152).

Finally, the agency costs theory is the view that admits the importance of other points ignored by Modigliani and Miller for the capital structure formation in a firm. In particular, the agency costs theory stresses the importance of debt and equity ratios, issues associated with the underinvestment, and free cash flows for the process of proper capital structure formation (Brigham, 2007, p. 16).

Background of Airline Industry

So, British Airways is one of the major players in the global aviation industry. The general background of this industry over the recent years also allows forming considerable ideas about the capital structure of firms in it on the whole, and about the capital of British Airways in particular. Thus, Zinnov (2007) argues about the 5.6% growth of the global aviation industry that was expected since 2004, and notices that European airlines were supposed to have over 60% of the world’s market under such conditions.

However, Brogden (2009) notices that recession affects the industry and reports 5.7% decrease of passenger numbers on the global scale in 2009, while the losses of airline operators in the same year amounted to impressive $4.7 billion. All these situational conditions are, at the same time, contrasted with the long-time industry developments that, for instance, allowed aviation service providers to increase productivity by 61% and fuel efficiency by over 20%. In the light of this fact, the investments into the airline industry grew by 49% between 1980 and 2007 (Zinnov, 2007; Brogden, 2009). The above figures reveal that the aviation industry is subject to various influences, and the capital structure of any of its players cannot but be affected by them.

British Airways

General Notions

British Airways is one of the world’s leaders in the sphere of airline services. The company was founded in 1919, when it carried another names, Aircraft Transport and Travel Limited (AT&T). Since that time, the company has changed several other names, but also included various new services to its range, including hotel booking, worldwide cargo deliveries, electronic ticket services, and other activities in the area of investor relationships (British Airways, 2010). All these fact allows British Airways to currently take one of the prominent place in the aviation industry at the global scale.

British Airways’ Industry Position

In more detail, British Airways enjoys one of the dominant positions in the airline industry. According to the 2009 annual report of the company, British Airways is expected to have 35% market share in the EU airline market and 21% in US market (British Airways, 2009). The annual revenue of the company grows regularly; this allows the British Airways to earn £8.992 billion in the end of 2009 fiscal year as compared to £8.753 in 2008, even through the global economic recession conditioned the decrease of airline services demand for over 6% for the same period (British Airways, 2008; 2009). Accordingly, the position of the British Airways in the industry is rather strong, although the recent changes in its capital structure give information for consideration, especially for airline investors.

Capital Structure

Cost of Equity between 2007 and 2009

So, the first element of the capital structure of British Airways is the cost of equity. Between 2007 and 2009, the cost of equity for British Airways has grown almost two times as far as only the dividend model is concerned. The formula for calculating the cost of equity in such case is:

  • Ko = Do / Po,

where Do is the dividend per share, while Po is used to refer to the current market value of stock of the British Airways. Accordingly for years from 2007 to 2009, the cost of equity for the dividend model is as follows:

  1. 2007: Ko = 20.995/615 = 3.4%
  2. 2008: Ko = 29.387/526 = 5.6%
  3. 2009: Ko = 36.417/600 = 6.1%

However, the growth can be seen much slower is the growth rate g is added to the formula to complete it:

  • g = √ (36.417/20.995)-1=31.7%

Accordingly, the formula for calculating the actual growth of the cost of equity, with the growth rate g added, and the calculations of the annual cost of equity meanings will look as follows:

  1. Ko = D1 / Po + g
  2. 2007: Ko = 29.387/615+0.317 = 3.6%
  3. 2008: Ko = 36.417/526+0.317 = 3.9%
  4. 2009: Ko = [36.417*(1+0.317)]/600+0.317 = 4.0%

From the above equations, it is seen that the cost of equity is greatly affected by the growth rate, which means, according to Grossman (2009, p. 184), that the company’s equity is highly levered, and the cost of debt proves this point.

Cost of Debt in 2007 – 2009

In more detail, the cost of debt in British Airways has been on the steady decrease between 2007 and 2009. It is important to notice that in 2008 the cost of debt fell by only 0.38%, while 2009 saw almost the double decrease of the figure. Thus, using the formula (10), it possible to trace the cost of debt dynamics:

  1. Kd = I * (1-t) / Pd
  2. Kd = 1,393*(1-0.33)/15,651 = 5.96%
  3. Kd = 1,547*(1-0.37)/17,464 = 5.58%
  4. Kd = 1,110*(1-0.33)/25,518 = 2.91%

Accordingly, two major assumptions can be made on the basis of the above calculated data. First, the decrease of the cost of debt of British Airways might have been conditioned by the increase of revenue and of the cost of equity. The latter two factors provided the company with all necessary internal funding, and British Airways cost of debt fell in the light of the decreased need of external financing as argued by Grossman (2009, p. 152). Second, British Airways might have reduced the cost of debt artificially to avoid the underinvestment, discussed by Brigham (2007, p. 142), in the light of the global economic recession and the debt / equity ratio that continued to grow between 2007 and 2009.

WACC in 2007 – 2009

Accordingly, on the basis of the data on cost of equity and cost of debt of British Airways for years 2007, 2008, and 2009, it is now possible to consider how the WACC (weighted average cost of capital) developed over the same period of time. In particular, this can be done using the formula that follows:

  • WACC = [RS*(S/V)+[RB*(B/V)],

where R marks the return on the capital, V is the value of the total company’s capital, B is used to refer to the total debt of the company, while S denotes the British Airways’ equity for the respective period. Thus, the three-year WACC dynamics can be illustrated as follows:

  1. 2007: WACC = [0.036*(93,690/109,341)+0.0596*(15,651/109,341)] = 3.94%
  2. 2008: WACC = [0.039*(91,303/108,767)+0.0558*(17,464/108,767)] = 4.17%
  3. 2009: WACC = [0.04*(101,613/127,131)+0.0291*(25,518/127,131)] = 3.78%

Thus, one can see that WACC of British Airways increased only in 2008 if compared to 2007, while the 2009 figure of WACC again displayed the decrease of this factor in the company’s operations.

Capital Structure Dynamics

All these details, i. e. calculations of cost of equity, cost of debt, and WACC in the period of 2007 – 2009 allow tracing the dynamics of the whole capital structure of British Airways over the same years. First of all, using the following formula (18) it is possible to see that the total capital of the company has fairly increased over the mentioned period of time:

  • V = B + S,

where V is the total capital as such, B refers to the total debt, while S marks the company’s equity. So, the total capital for the period of 2007 – 2009 grew as follows (British Airways, 2007; 2008; 2009):

Year Calculation Total capital
2007 £15,651 + £93,690 £109,341
2008 £17,464 + £91,303 £108,767
2009 £25,518 + £101,613 £127,131

Further on, the structure of the capital changed as far as the cost of equity grew and cost of debt decreased drastically in British Airways (British Airways, 2007; 2008; 2009):

Year Cost of Equity Cost of Debt
2007 3.6% 5.96%
2008 3.9% 5.58%
2009 4.0% 2.91%

Interestingly, the dynamics of WACC for the company coincides with the dynamics of its tax payment percentages over the period of 2007 – 2009 (British Airways, 2007; 2008; 2009):

Year WACC Taxes
2007 3.94% 33%
2008 4.17% 37%
2009 3.78% 33%

Thus, it can be seen that the dynamics of the capital structure of British Airways developed according to the agent costs theory in the period of 2007 – 2009, as far as the WACC levels were directly affected by the tax payment of the company, while its cost of equity increased, when the cost of debt fell in the context of the global economic recession and having enough funds for internal financing.


Thus, the above presented discussion allows concluding that the capital structure of any business company is an essential element of its functionality and attractiveness for partners and investors. To a great extent, the capital structure determines the success of the company in the market, while the latter can change the capital structure of companies. The example of British Airways proves these points as far as the dynamics of development of the capital structure of this company coincided with the change of market and global economic conditions.

Reference List

Brigham, E. (2007). Fundamentals of financial management. Cengage Learning.

British Airways. 2006/2007 Annual Report and Accounts. Web.

British Airways. 2007/2008 Annual Report and Accounts. Web.

British Airways. 2008/2009 Annual Report and Accounts. Web.

British Airways. (2010). Official Corporate Website. Web.

Brogden, L. (2009). Development Trends in the Airline Industry. Web.

Grossman, T. (2009). The Portable MBA in Finance and Accounting. John Wiley and Sons.

Zinnov, L. (2007). Global Aviation Markets – Analysis. Web.

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