The organizational and operational factors that affect investment decisions
Middle Eastern airlines have been successfully used for marketing their respective countries. Their unparalleled luxury and business acumen have earned wide admiration from across the world. Their main purpose has been to connect the dots throughout the world, resulting in tremendous economic growth. Indeed, most of these airlines have eased the cost of doing business in their regions as well as boosted their tourism sectors. However, these successes by the leading airlines in the Middle East did not just come about accidentally. The most notable airlines in the region, Qatar Airways, and Etihad Airways, have been strategic in their investment decisions over the years. Notably, Etihad Airways has been heaving purchasing and investing in foreign airlines.
Etihad Airways’ investment decisions have not all been rosy, nonetheless. In many instances, some of its investments have dramatically collapsed. Alitalia, Air Berlin, and Jet Airways are some of its investments that have collapsed. Virgin Australia airline is also on the verge of a downfall. Etihad Airways seemed to have overlooked some critical issues before carrying out its investment decisions. Some of these airlines had deep-rooted issues that needed to be resolved first before Etihad Airways could purchase them. For instance, Alitalia had endless issues with its trade unions, a factor that tremendously increased operational costs. On the other hand, Air Berlin experienced stiff competition from Europe’s low-cost carriers. This was the same case with Jet Airways, Vistara, and Air India.
When Etihad Airways bought a 29% stake in Air Berlin, it found it with a $652 million debt. In order for the airline to stay afloat, Etihad Airways lent it $213 million in addition to paying it $79 million. Despite all these efforts by the Abu Dhabi-based airline, Air Berlin did not make any profits and eventually demised in the year 2017 (Vernimmen et al., 2017). This is just one example of how poor investment decisions can be detrimental to an organization.
Etihad Airways’ leading factor for investment is to compete with the regional giants- Qatar Airways and the Emirates. It wants to make a place for itself against the shadow of its more established neighbors (S.Mahtani, 2018). Thus, by investing in other airlines, Etihad Airways looks forward to making inroads in as many destinations as possible and bringing feeder traffic to Abu Dhabi.
Other than the need to compete, the investment decisions of Etihad Airways were primarily affected by five factors. These include interest rates, economic growth, confidence and expectations, technological development, and availability of finance.
As the business environment keeps on changing, it brings with it a new set of environments that requires business managers to thoroughly evaluate their investment decisions. These decisions are influenced by a myriad of factors that keep on changing from one region to the next. To put this into perspective, this paper will focus on Etihad Airways, a leading commercial airline in the United Arabs Emirates. The aim of this paper is, thus, to establish and analyze the corporate financial decisions of the airline.
Interest Rates
Almost all organizations finance their investments through borrowing or current savings. This implies that interest rates play a pivotal role in investments. When the interest rates are high, a business finds it expensive to borrow. On the other hand, high-interest rates assure an organization of better return rates from keeping its money in the bank (Patil & Bagodi, 2021). Therefore, with higher rates of interest, Etihad Airways’ investments came with higher opportunity costs since it lost out on the interest payments. According to the marginal efficiency of capital, a worthwhile investment gives a higher return rate as compared to the interest rate. Hence, if an interest rate is 5%, then Etihad Airways’ purchase of another airline should give it a return rate of 5% or more, for instance (Patil & Bagodi, 2021). However, if the interest rates continue to increase, the number of investment projects that will be available for the airline will continue to diminish (Alnahedh & Alrashdan, 2021). However, if the interest rates are reduced, then there will be more worthwhile investment projects for Etihad Airways. If interest rates are increased after an organization has initiated an investment project, the organization will be least likely to stop the project but will think twice about future investment opportunities. This implies that changes in interest rates sometimes do not have instant effects on an organization, but it takes time before their impacts are felt.
Economic Growth
One of the primary reasons why organizations invest is to meet future demands. Etihad Airways considered that the ailing airlines would soon collapse. It thus rushed to buy them off for purposes of, among other things, acquiring their clients. A rise in demand encourages organizations to increase their investments. However, in addition to the customers brought about by collapsed airlines, an increase in the economic prospects of a country also creates a new set of customers (Bowen III et al. 2017). Countries doing well economically have many of their citizens traveling from one destination to the other quite frequently. Such countries attract more airlines, a factor that Etihad Airways capitalized on. It must, however, be noted that investment is cyclical. This means that countries doing badly economically attract fewer flights. Thus, Etihad Airways will reduce investments in such countries and instead refocus them on economically viable destinations. According to accelerated theory, investment is directly proportional to the rate change of a country’s economic growth. This implies that if a country’s economic growth rises from 2.0% to 2.6% within a year, then this growth increase will trigger a rise in investment spending with the same margin (Elhashala et al., 2021). This explains why Etihad Airways increased its investments in countries across Europe and Asia.
Confidence
About 12 years ago, Etihad Airways invested in Manchester City’s football club based in England. Despite the fact that as a result of the deal, the airline invested millions of dollars in the then-struggling club, the investment brought a good return. Part of the deal included Etihad Airways increasing their daily flights to Manchester City to more than two flights, having stadium naming rights as well as shirt sponsorship (Patil & Bagodi, 2021). This was expected to enhance the airline’s global visibility as well as increase its media value. Despite the fact that the club was not performing well before the partnership, the appearance of Etihad Airways onboard brought good news. Etihad Airways invested in the club because it had confidence that such investments would not only improve the club’s performance but also bring more visibility and business to the airline. A country’s political and economic climates can either lower or promote an organization’s confidence in it. Etihad Airways considered England’s economic and political environment as conducive for business and worthy of investments (Graham, 2020). Confidence is also boosted if an investment destination has low rates of inflation.
Technological Developments
Technology has tremendously tilted up the scales for business operations, including the airline industry. Changes in technology have a direct influence on an investment’s attractiveness. Augmented reality and virtual reality applications are gaining traction in the airline industry. AR/AV-based apps like Foe are increasingly being used in airport spaces across the world to assist passengers in navigating the airport’s complex layouts and keeping planes safe (Bose, 2018). If Etihad Airways wants to compete effectively with its rivals, it must also invest in such technologies. Investments in artificial intelligence will boost its customers’ experiences through voice-based tools and chatbots, for instance (Cyrino et al., 2017). Unlike before, today, before arriving for their flights, passengers are required to register their relevant biometric information on their mobile phones to help reduce queues at airports. These are some of the new realities that are significant factors occasioning Etihad Airways to consider investing in technological developments.
Availability of Finance
Over the last two decades, the government of the United Arabs Emirates has pumped more than $22 billion into Etihad Airways to aid in its various investment undertakings. The extent to which the government has assisted the airline has elicited some squabbles among its toughest competitors- Emirates and Qatar Airways, who have termed subsidies as unfair to competition (Narayanan & Odeh, 2020). With this availability of resources, the airline is empowered to carry out all the important investments it wishes.
How corporate strategy can determine investment decisions
An investment decision is a decision by an organization to efficiently invest its current fund in long-term assets with expectations of benefits flowing over time. Some of the benefits anticipated from investment decisions by a firm include acquisition, replacement of old assets, expansions, and modernization. Other benefits include divestment, research, and development, and change in sales and distribution methods (Schulz & Wiersema, 2018). If an investment decision is well formulated and executed, it helps to mobilize and channel an organization’s resources into a viable and distinct posture based on its short-term comings and relative interval competence. This is in addition to the expected changes in the operational environment and contingent actions by its rivals (Vernimmen et al., 2017). Through corporate decision-making, an organization is able to establish and disclose its purposes, goals, and objectives and develop the principle plans and policies that will be used to achieve the set objectives. It also helps in defining the business prospects that the firm can pursue as well as the identity of both economic and non-economic commitments it wishes to make to its stakeholders (Elhashala et al., 2021). Effective corporate decision-making hence plays a significant role in backing the type of business in which an organization can compete, specifically its investment decisions. Since this is its main driving force, an organization must, thus, diligently formulate a strategic corporate decision that will determine its general direction with regard to its policies, action sequences, and goals.
Among the many decisions that a business must make every day is whether to remain in competition presently and in the future. At Boeing, corporate investments in the right processes and technologies at the most appropriate time are crucial to its success (Jung, 2021). Boeing plans its research and development in technology actively in such a way that it maximizes its potential returns. This way, the company manages to fuel its bottom- and top-line growth.
The decision by Boeing on the specific processes and technologies to adopt is based on several factors that should always be balanced together (Varma et al., 2018). However, the most crucial factors are the extent of the immediacy of the particular need and the availability of funds. This way, the company aims to get the most from its investments in research and development (Schulz & Wiersema, 2018). Subsequently, it manages to strike the right balance between delivering returns to its shareholders and investing in the future.
It is policy of Boeing to invest 4% of its overall annual revenue in R&D, which is carefully distributed among its different units. The primary focus of Boeing’s business units is on their near-term needs for process and product improvement and development. The centrally managed unit at Boeing emphasizes the provision of technologies and systems that aim to benefit products across all units of the business (García-Meca et al., 2017). One of the approaches used by Boeing to ensure that it maximizes returns from its investments is to make a technology process that prioritizes what works best. This process begins with the evaluation of the common technology needs of Integrated Defense and Commercial Airplanes.
The strategies
The main corporate strategies used by Etihad Airways include expansion, diversification, integration, and concentration (S. Krause, 2019). Over the last decade, Etihad Airways has been on an ambitious expansion strategy. Its actions to buy off struggling airlines across Europe and Asia were all expansion strategies deployed by the airline to broaden its reach. In 2017, the company announced plans to deploy Boeing 787-9 aircraft to Madrid, Athens, and Amsterdam to boost its network of European Dreamliner (Palma-Ruiz, 2020). During then, only 13 Boeing 787-9 aircraft were operated by the company in eleven destinations. Over the coming years, the airline has indicated plans to acquire up to 58 Dreamliners and effectively increase its destinations.
Etihad Airways has also entered into alliances that will see it improve its environmental sustainability. This expansion strategy will mainly emphasize enhancing flight operations and navigation efficiency as well as sustainable practices and airframe technologies whose primary objective will be to reduce fuel emissions and use. Etihad Airways asserts that sustainability is one of its key principles (Jung, 2021). Therefore, by entering into an agreement with Boeing, Etihad Airways hopes to expand its sustainability message to a wider reach and consequently attract more clients.
The concept of expansion has also seen Etihad Airways enter into a partnership with the United Kingdom’s Digital Aviation Research and Technology Center to offer the real-world operational capability and valuable insights to help drive its sustainability agenda. This arrangement will see the airline create secure, efficient, and safer airspace, reduce emissions, and increase aircraft availability and reliability (Hillier, 2016). Out of this partnership, a research center dedicated to the achievement of the objectives will be built. In addition, the airline has also been keen on integrating the culture of the UAE into its operations. For several years, the company has sponsored the Arab Film Festival to showcase the rich culture of the Arab world. It prefers to be associated with the falcon, which it describes as a significant, indelible part of the Arab culture as well as the country’s national symbol.
The COVID-19 pandemic has taught many businesses, especially those in the airline industry, the need to diversify (Palma-Ruiz, 2020). Although a huge chunk of Etihad Airways’ revenues comes from passenger flights, the airline has also invested in other areas that give it revenue. The airline has invested in the hospitality industry, where its main focus is the promotion of the Arabian culture as generous and warm (Redpatha et al., 2017). The Etihad Holidays and Etihad Airport Services Catering are auxiliary business entities that ensure that Etihad Airways has other revenue streams. In addition, Etihad Airways has partnered with the Manchester City club in England.
Ever since it was established in the year 2003, integration has been one of Etihad Airways’ key selling points. The company has effectively integrated technology into its operations to enhance customers’ experiences. To automate the management and monitoring of its guests, the company has integrated IBS software solutions, which also track baggage journeys (Boisjoly et al. IV 2020). The integration of technology into the operations of the airline has also increased situational awareness through alerts and dashboards, which are then conveyed in the operational control room (Rodríguez-Sánchez et al., 2020). Moreover, it ensures that the airline enhances punctuality and reduces flight connections.
The company has also undertaken strategic moves that have seen it concentrate some of its operations. This has been primarily achieved through downsizing. Etihad Airways’ rapid expansion in an attempt to match and perhaps outdo its competition has also been counterbalanced by divestments through scaling down of its fleets, particularly in its partner airlines (Fabo et al., 2017). The company has consistently argued that for it to adapt to the ever-changing marketplace, it is essential for it to adjust its business and position itself as a mid-size carrier. This is a departure from its once ambitious strategy of buying big carriers. Concentration also entails the withdrawal of Etihad Airways from the partnership that it had with Jet Airways, Alitalia, and Air Berlin (Bücker & Horst, 2017). The company also allowed the 49% stake it had in Air Serbia to be reduced to 18% by the country’s government after recapitalization. In addition, the effects of the COVID-19 pandemic saw the airline ground some of its double-deck aircraft’s ten-strong fleets.
The Decisions
- In 2011, Etihad Airways entered into a joint partnership with Air Berlin, which saw the German carrier relocate its operations to the Middle East. The Abu Dhabi-based airline acquired a 29.1% stake in Air Berlin, making it the biggest single investor to make such a huge move.
- In 2011, Etihad Airways entered into a sponsorship deal with club Manchester City for a sum totaling £400m. As a result of the deal, the City’s ground was renamed Etihad Stadium. The deal also included a ten-year shirt sponsorship for the club and financial backing.
- In 2013, Etihad Airways purchased a 24% stake in India’s Jet Airways for $379 million. In addition, it also guaranteed Jet Airways soft loans to pull it out of its financial troubles.
- In 2014, Etihad Airways acquired a 49% stake in Alitalia in exchange for investing up to 560 million euros in the struggling airline.
The Investment decisions
Application of models that can influence investment strategy and decisions of Etihad Airways
Three Statement Model
In this model, income statements, cash flow, and balance sheets are dynamically linked into one financial model. It is upon this model that more cutting-edge financial models, such as the merger model, discounted cash flow DCF models, and the leveraged buyout is built (Amenc et al., 2019). Its primary objective is to design it in such a way that it connects all accounts. Linking all three financial statements is instrumental as it is the basis of finance and accounting (Adji et al., 2018). One must have solid Excel skills to be able to do this.
Discounted Cash Flow (DCF) Model
A discounted cash flow model is a particular financial model type mainly applied in valuing a business. It is a forecast of the unlevered free cash flow of an organization that is discounted back to the present-day value. This is referred to as the Net Present Value (NPV). Incidentally, the three-statement financial model is the DCF model’s basic building block. It helps to connect all the financials of an organization (Alnahedh & Alrashdan, 2021). The DCF operates by extracting cash flow from the three-statement financial model and uses Excel’s XNPV function to discount them back to the present day at the Weighted Average Cost of Capital (WACC) of the company (O.Fasanya, 2021). It is done after making all the necessary adjustments to the three-statement financial model.
Merger Model (M&A)
The merger model belongs in the financial models’ Valuation Category. This is a financial modeling type that gravitates towards a more complex model that is applied to assess the dilution or the pro forma accreditation of an acquisition or a merger. Quite often, a single tab model is used for each organization. Here, the formula, Company A + Company B = Merger Co, represents the consolidation (Koilo et al., 2020). There can be a wide gap between the complexity level in this model, which is more commonly used in corporate development or investment banking.
Three Statement Model
In this model, income statements, cash flow, and balance sheets are dynamically linked into one financial model. Its primary objective is to design it in such a way that it connects all accounts and generates a set of assumptions that can trigger changes throughout the entire model (Koilo et al., 2020). This three-statement model is very easy to use and provides the position of the cash flow in the organization. It is the cash flow position that will provide information on whether Etihad Airways has enough cash to carry out various investments or to seek financial assistance from the government (Foster, 2019). By changing assumptions based on different airline scenarios, Etihad Airways gets more opportunities to make more informed investment decisions.
Discounted Cash Flow (DCF) Model
This model draws cash flow from the three-statement model and the Free Cash Flow to discount them back to the present day of the Weighted Average Cost of Capital of the company using the Net Present Value. The Free Cash Flow is obtained by adding Net Profit to Depreciation & Amortization and Interest, then removing the Capital Expenditure (Waddinton, 1999). On its part, the Weighted Average Cost of Capital is obtained using the Cost of Debt, the Percentage of Equity and Debt, and the Risk-Adjusted Cost of Capital. Incidentally, the DCF model considers Free Cash Flow, which is the actual measure of the amount of cash left in the organization (Foster, 2019). In addition, in the calculation of the Weighted Average Cost of Capital, the risk in business and the industry that the airline belongs to is accorded much consideration.
Calculations for the Discounted Cash flows, NPV and IRR
Discounted cash flow (DCF) is a method of valuing an investment that is used to determine its value based on its expected future cash flows. DCF analysis is used to determine the current value of an investment based on future cash flow projections (Fernández, 2019).
Discounted Cash Flow Formula
The DCF Formula is:
DCF= (CF/(1+r)1 + CF/(1+r)2 + CF/(1+r)3 +…….+ CF/(1+r)n
Where: –
CF: is the total cash flow for a given year
r: Is the discount rate = 5%
Year
Diploma Project
Discounted cash flow
0
Initial Investment = 1,200,000 SR
Profit = 500,000 SR
476,190
2
Profit = 500,000 SR
453,514
3
Profit = 500,000 SR
431,918
4
Profit = 500,000 SR
411,351
5
Profit = 500,000 SR
391,763
Final Profit
2,164,736 SR
Looking at it
Then, the calculation will be
= 5000/(1.1)^5
=8052.54
NPV
= 1.84%
IRR = 0.93%
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