Southwest Airlines Vs. American Airlines Term Paper

Southwest's interest coverage is comfortable, at 3.909. Southwest's operating leverage is high, as they are in a low margin business. They had a negative change in EBIT over the period, as did AMR, despite both having higher sales. Southwest's combined leverage is 1.505, much stronger than AMR, which suffered a huge decline in earnings per share despite having higher sales.

10) the weighted-average cost of capital for Southwest is 0.56%. This is based on a risk free rate of 1.2% (three-month T-Bill) and a historic return on the Dow Jones of 3.2%. For AMR, the WACC is 3.53%. This reflects that AMR's equity has a negative value, and that they do not pay dividends. Their cost of capital is the cost of their debt.

11) LUV's chart is very stable, whereas AMR's is not. AMR has been highly volatile in the past couple of years, showing strong gains and then a consistent decline. Over the same period, LUV has been virtually flat, with a slight dip at the end.

12) the growth rate for the last five years of LUV's earnings has been an average of 7.8%. This gives the present value of their next five years' earnings respectively to be $691.43, $741.21, $794.54, $851.76, and $913.12 for a total of $3,992.09. The P/E ratios for the past four quarters, based on trailing 12-month EPS are 14.35 for the latest quarter, 19.22, 24.47, and 21.94. The P/E had risen in the second quarter after a strong earnings figure but as those earnings began to decline, the price of the stock started to slip as well. Investors no longer believed in strong growth prospects for LUV.

13) Right now I would hold LUV.It is fairly valued, in my opinion. The recent FAA troubles seem to have not affected the stock so much as weaker earnings. The high P/E we'd seen in six months to a year ago was probably too much, given the growth prospects for LUV. Therefore I feel it has settled down into better price range.

Exhibit a:

LUV AMR

Gross Margin: 26.14-21.83

Operating Profit Margin: 8.02 4.21

Net Profit Margin: 6.54 2.2

ROA: 4.27% 1.75%

ROIC: 0.26% -0.01%

ROE: 9.63% 49.15%

Current Ratio:.92.85

Quick Ratio:.86.78

Cash Ratio:.574.554

Debt/Equity: 1.416 -48.6

Interest Coverage: 31.64 1.73

Exhibit B:

Dupont Number

Net Income/Equity 111/6941 = 0.16 (69)/(606) = 0.113

Exhibit C:

Financial Leverage:

Debt/Equity 1.416 -48.6

Debt/Value.586 1.021

Interest Coverage 31.64 1.73

Operating Leverage:

change in EBIT change in sales -27.6/9.5 = -2.905 -5.05/5.3 = -.095

Combined Leverage:

change in EPS change in sales 14.3/9.5 = 1.505 -450/5.3 = -84.9

Exhibit D:

WACC = Wd (1-t) Rd + WeRe 586(1-.393).015 +.414(.0014) 1.0207(1)(3.46) + 0 total WACC.0056% 3.53%

Bibliography

Ratios except ROIC from Reuters. Retrieved April 10, 2008 at http://stocks.us.reuters.com/stocks/ratios.asp?symbol=LUV&WTmodLOC=R2-Ratios-1-More

ROIC, leverage and Dupont calculated from data from the latest quarterly and annual reports. Retrieved from Southwest.com and American Airlines.com on April 9, 10, 11, 2008.

On the WACC, betas, risk free and market return from MSN MoneyCentral. Retrieved April 11, 2008 http://moneycentral.msn.com/detail/stock_quote?Symbol=luv

Southwest corporate history from Southwest.com, retrieved April 8, 2008 at http://www.southwest.com/about_swa/airborne.html (April7, 2008) Southwest Airlines Travel….....