Fly-By-Night International Group: Can This Company Be Saved?

Fly-By-Night International Group: Can This Company Be Saved?

a.

Significant increase in fixed assets (220 percent) and related debt (318 percent) in Year 13 followed by only a 50 percent increase in sales in Year 14 led to significant diseconomies of scale. If we assume that the cost of services and selling and administrative expenses are variable (some portion is likely to be fixed), then the cost structure and breakeven appear below:

Break-Even Sales Analysis:

Year 10 Year 11 Year 12 Year 13 Year 14

Sales ............................. 100.0% 100.0% 100.0% 100.0% 100.0%

Variable Expenses......... (82.0) (62.7) (77.1) (79.4) (80.1)

Contribution Margin...... 18.0% 37.3% 22.9% 20.6% 19.9%

Fixed Expenses:

Interest ....................... $2,600 $2,743 $1,101 $3,058 $5,841

Depreciation............... 3,003 2,798 1,703 3,550 9,810

Breakeven Sales ............ $31,128 $14,885 $12,245 $32,078 $78,648

The increase in sales in Year 14, although impressive, was not sufficient to provide for profit and cash flow. It is not clear why FBN would purchase so many additional aircraft. Perhaps the firm had an opportunity to purchase the fleet of a corporation that was disposing of its aircraft and they were able to obtain an attractive price for the fleet. Perhaps FBN anticipated new government contract work and wanted to gear up its capacity accordingly.

Excluding discontinued operations, the ROA, profit margin, assets turnover, and ROCE indicate declining profitability between Year 12 and Year 14. The cost of services in Year 12 and Year 13 increased faster than sales. Perhaps FBN hired the pilots for their new aircraft in anticipation of new government contracts. The pilots may have fixed salaries for a portion of their compensation. Selling and administrative expenses increased faster than sales in Year 12 and Year 14. Depreciation expense increased faster than sales in all three years due to the addition of new aircraft.

Although cash flow from operations was substantial in Year 13 and Year 14, it occurred largely because of stretching accounts payable and other current liabilities. There are limits as to how much a firm can stretch these items to conserve cash.

During Years 12 to 14, FBN assumed increasing amounts of variable rate debt to purchase aircraft. It is unclear whether FBN could pass along any interest rate increases on this debt to the government under its contracts. The fact that interest