Hong Kong Dragon Airline Case Study Report

Hong Kong Dragon airlines was founded in May 1985, which is a subsidiary wholly owned by Hong Kong Macau International Investment Co by the local industrialist K.P. Chao.

After several years of development, the company’s 89% stake was acquired by CITIC Pacific and Cathay Pacific Airways in 1990.  In 2006, the engineering manager and finance manager was pointed as a taskforce leaders, who’s mainly task was to evaluate the different option to replace the spare engine that had been determined to beyond economic repair.  Basically, there are three options: first, they can purchase a new engine from the manufacturer; second, a direct lease offer; third, a sale-and-leaseback.  In order to evaluate the different options, the mainly task is determine the discounter rate for the Dragonair. However, the Dragonair was not a listed company, therefore using Cathay Pacific Airways as a proxy.  Cathay Pacific Airways is an international airline registered and based in Hong Kong.  The reason that Cathay Pacific Airways could be a proxy was not only both of these two companies were in the same industry but also their risk profile, type and maturity of debt were similar.  So we gathering the information from the annual report of Cathay Pacific Airways limited 2004 to calculate the discount rate.

Cost of debt

As the formula says, Cost of Debt = Net interest / Net Debt.

In Consolidated Profit and Loss Account sheet of Cathay Pacific Airways’ annual report in 2004, it shows that the Finance charges was negative 1,628 Million HK dollar, and the finance incomes was 1,045 million HK dollar. So we can get the net finance charges was negative 583 million HK dollar. We can set it as the net interest.

At the same time, in the Balance Sheet, the net long-term liabilities was negative 17,662 million HK dollar in 2004 and 21,418 million HK dollar in 2003. The average net long-term liabilities was: (17,662+21,418)/2 = 19,540 million HK dollar. The net current portion of long-term liabilities was 4,969 million HK dollar in 2004 and 4,879 million HK dollar in 2003, so the average net current portion of long-term liabilities was: (4879+4969)/2=4,924 million HK dollar. Above all, the Net Debt was equal to the sum of Average net long-term liabilities and Average net current portion of long-term liabilities. It was: 19,540+4,924= 24,464 million HK dollar.