Hong Kong Dragon Airlines (a)

Hong Kong Dragon Airlines (A)

October 25th, 2016

WACC Analysis

In order to decide what option Hong Kong Dragon Airlines should take to obtain the new engine, the discount rate is needed to figure out the NPV for the company due to this being a long-term investment. To figure out the discount rate there are numerous steps into calculating the WACC. First the cost and weight of equity and debt had to be found to complete part of the WACC formula. The first part of the formula I found was the weight of equity and debt and then their costs. Calculating the cost of debt, the bond rating must be found since Hong Kong Dragon Airlines is a privately traded company. After comparing airlines, China Southern Airlines and Thai Airways were similar so I used their bond ratings of “A” which came out to 120 bps. The second thing that had to be decided, was to use the 1 year exchange rate or the 10 year. Since this project has a long life, the holding period should also be long, which is why I used the 10 year. As mentioned, Hong Kong Dragon Airlines is privately traded, so there was some other missing information that was given such as the beta and the corporate tax rate using Cathay Pacific as a proxy.

The second part of WACC the cost of equity had to be found. The challenge that came with this was deciding which market return to use for the Hang Seng index. I decided to use the average of the market over the past 10 years because I believe that it captures the best overall data and again, since it is a long-term project the average for 10 years was necessary. After combining all parts of the WACC my calculation came to 6.02% which would make Hong Kong Airlines a higher risk with their operations.

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