Optimizing Capital Structure for EUROCARIB

The assignment requires a detailed analysis of EUROCARIB's financial situation, identification of strengths and weaknesses, and development of a strategic framework to enhance the company's financial performance. This includes assessing the viability of proposals, using techniques of investment appraisal, and evaluating the impact of different capital structure options on the company's financial position.

Finance and Funding in the Travel and
Tourism Sector

Table of Contents
INTRODUCTION...........................................................................................................................................1
TASK 1..........................................................................................................................................................1
A. Examine the concept of CVP analysis and its importance...................................................................1
B. Pricing methods...................................................................................................................................3
1.3 Analysis of factors affecting travel and tourism business..................................................................4
2.1 Different type of management accounting information that can be used in the business...................5
2.2 Assessing the use of investment appraisal techniques as a decision making tool.............................7
TASK 3..........................................................................................................................................................8
Analyzing financial statements of Thomas Cook.....................................................................................8
TASK 4........................................................................................................................................................13
Analyzing sources of funding that can be obtained by firm for developing new hotel..........................13
CONCLUSION.............................................................................................................................................15
REFERENCES..............................................................................................................................................16

INTRODUCTION
Finance is the crucial and highly important requirement of every business because none
of the enterprise can operate in tough market with lack of access to sufficient fund. Not only the
fund collection is sufficient but also needs to be managed, supervised and administrated strongly
to achieve set financial goals. EUROCARIB TOURS is a London-based tour operator that
launches various trips and tours at the attractive tourist destinations all over the world. Company
provide luxury facilities to all the visitors to provide them a wonderful travelling experience. The
current research study aims at examining the key aspects of business success including pricing
and factors that affect business profitability. Moreover, it will examine the key managerial tools
like cost-volume-profit analysis, investment appraisal and other methods of management
accounting which cited organization can use for growth. Despite this, in order to examine
financial success or health of the organization, a number of quantitative ratios including
liquidity, solvency and profitability will be compute and accordingly, firm will be suggest to use
new tactics to improve their financial performance. Lastly, various sources from where tour
operator can generate funds will be critically evaluated.
TASK 1
1.1 Examine the concept of CVP analysis and its importance
Cost-Volume-Profit-Analysis (CVP) is an important tool of cost accounting that gains
crucial importance for the short-term management decisions. The method is used by the
companies to assess that how changes in various costs elements, selling prices and sales volume
will influence bottom line of the business. The method believes that various costs of the
company can be classified into fixed or variable cost elements including manufacturing,
administrative, marketing and others (Choo and Tan, 2011). As per the case, a major tour
operator in London, named EUROCARIB TOURS is keen to invest in a summer holiday trip at
Caribbean Holiday Resort lasting 4-week. In order to serve customers with the luxury facilities,
it book hotel and airplane for the users. Here, CVP analysis is helpful for the company to
perform sensitivity analysis means how its net profitability will be influenced by number of
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potential booking and other factors. The key importance of the tool for EUROCARIB TOURS
managers to make b better decisions is discussed underneath:
Contribution margin: Marginal costing method differentiates fixed & variable costs
elements and shows it separately. For the planned summer trip, cost of accommodation to
provide luxury hotel facilities to the guests is the fixed costs because hotelier charges a fixed cost
under the contract from the company (Weiss, 2010). However, other costs like travelling,
documentation, food & beverage facilities are variable costs because it depends on the number of
guests going to the tour. Income statement prepared following marginal costing method subtracts
total variable costs from the turnover to reflect contribution margin.
Contribution=Salesrevenue – Total variable costs(TVC )
Sales=(Price∗number of guests)
TVC =(Number of guests∗variable costs each consumer)
¿( £ 1,600∗90) – (90∗£ 400)
¿ £ 144,000−£ 36,000
¿ £ 108,000
Thus, EUROCARIB TOURS will gain contribution of £ 108,000 if, there are 90 guests
ready to visit the tour.
Operating income: Marginal income shows surplus of total income over the total
expenditures. In other words, excess of contribution over fixed costs is known as operating
income (Garrison and et.al., 2010). EUROCARIB TOURS incur fixed costs for accommodating
people. It is not related to the number of visitors because firm had signed a fixed contract with
the hotelier to accommodate people. Thus, if in any case, company do not have sufficient
demand as per the expectations, then, it will not impact the contract prices because as a result of
advance booking; hotel will not be able to serve other guests/
Operating income=Sales – Variable costs – ¿ costs
Operating income=Contribution – ¿ costs
¿ £ 108,000−£ 120,000
¿ £ 12,000
The results shows that if tour operator has a demand of 90 guests wishing to go on the
trip, then firm will bear net loss worth £12,000.
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Desired sales volume: One of the another key benefit associated with the CVP analysis is
that it enable formulators to clearly set the target sales volume which generates expected return
(Pavlatos and Paggios, 2009).
Desired sales volume : ¿ costs+ Desired return /Contribution per unit
Contribution per unit : Selling price – total variable costs
¿( £ 120,000+ £ 30,000)/(£ 1600−£ 400)
¿ 125
EUROCARIB TOURS must attract 125 visitors on the tour so that its target profitability
of £30,000 can be achieved. At this level, contribution will be (£ 1200∗125)=£ 150,000.
Break-even point: The point which shows the best and most effective utilization of
resources is known as break-even point (Bebbington and Thomson, 2013).
Break−even point=Total ¿ cost /CPU
¿ £ 120,000/ £ 1200
¿ 100 visitors
BEP( £ )=100 visitors∗£ 1600
¿ £ 160,000
As per the results, it is clear that if there are only 90 tourists, EUROCARIB TOURS
should not plan the trip and put effort to maximize sales volume to 100 visitors to reach the
maximum point. If actual demand goes beyond that level, then it would be profitable for the
firm.
1.2 Pricing methods
Pricing is an important decision for tour operator which is a process of setting charges
that company will charge for the services provided. There are multitude of method which might
be used by the firm to set a right price as per the consumer need, enumerated underneath:
Cost-centered decision: As name itself, initially, the method determine total costs of the
planned tour including both the fixed and variable costs elements i.e. accommodation, air fare,
transportation and others. Total costs are allocated to the potential number of visitors to assess
unit costs. In this, expected margin is added together to fix selling price (Weiss, 2010. The
strength of the method is that it applying the method, EUROCARIB TOURS can easily recover
all the costs incurred. Moreover, company is sure that it will generate return by charging selling
prices with some margin above costs.
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Competitive selling pricing: This method set prices of every tour operator after scanning
the external market. In this, key competitors are taken into account and their prices are examine
which enable EUROCARIB TOURS to set highly competitive charges. It enable firm in
successfully attracting more audience base as competitive or highly-concentrated prices gives
tough competition to the rival organizations. However, based on product differentiation, firm can
charge a bit higher prices by providing unique services to the end-users.
Demand based pricing: Under this method, prices are set by the organization after
analyzing potential market demand. It means, if there is larger number of guests expected to visit
on the tour, than it means, EUROCARIB TOURS will be able set higher charges for the planned
tour. In contrast to this, in case of lower demand, firm must charge cheaper prices so that more
prospective buyers can be attracted on the tour and thereby sales volume can be raised. Thus,
such pricing tactic helps firm in setting an appropriate price that helps business to succeed.
Target return: According to the name itself, prices are fixed after incorporating a target
return on the costs. The best part of the method is that it helps companies in generating some
return by charging greater prices above costs (Pavlatos and Paggios, 2009).
Seasonable pricing: Travel industry grows at rapid rate during vacations and holidays
when more number of buyers wish to go attractive tourist destinations all over the world. Thus,
in these pricing mechanism, period when market demand is very high, prices is charge high.
Unlike this, during period when there is very low market demand, EUROCARIB TOURS can
charge less and attract more audience base to drive larger sales volume and gain maximum
profitability.
Going rate: This method pays special attention to the prices of industry leaders and key
players. Besides this, external market environment such as demand fluctuation, political and
regulatory uncertainty, social preferences and others are considered to adjust charged prices
(Baumol and et.al., 2012).
1.3 Analysis of factors affecting travel and tourism business
There are number of factors that have due impact on travel and tourism business. It is very
important to take in to account these factors so that prudent decisions can be taken in the travel and
tourism business. Some of the relevant factors are as follows. Seasonal variation: It is the one of important factor that has due importance for the firms.
Seasonal variation refers to the situation where in few months sudden peak is observed in sales of
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the products and services in the business. On other hand, in case of seasonal variation sometimes
sales declined consistently during off season. Hence, firm operating in travel and tourism sector
needs to consider seasonal factor while making any business decisions (Costa, Panyik and
Buhalis, 2014). During season firm can charge high product for its price and can earn maximum
profit but during off season in order to ensure survival of business it become important to reduce
product price. Thus, it can be said that seasonal variations have impact on tourism business. Economic environment: Economic environment is another factor that have due impact on the
business firm. Government of the nation frequently makes changes in its monetary and fiscal
policy and all these things positively and negatively affect business firms. Change in monetary
policy make availability of loan cheaper and costlier. Similarly, fiscal policy has impact on
taxation rate. Alteration in these policies has impact on profitability of the business firm. Thus, it
is very important to take in to consideration economic factors while making investment decisions. Political environment: Political environment also affect travel and tourism business. This is
because ideology and steps taken by the firm determined way in which nation economy will go.
In every nation government prepare plans and policies for its benefit and all these things in some
way affect firms operating in the nation. Hence, it can be said that political environment have due
impact on these firms and it is the one of factor that have due impact to travel and tourism
business. Social environment: Social environment have due impact on the business firms as it can be
observed that it contain ideologies and beliefs that people have towards firm and its product. All
these things have impact on sale of the firm products and number of factors in the business. It can
be said that social environment must be considered and according to it product must be designed
so that it can be acceptable to all sort of people. Staff: It is another factor that has very huge impact on the business firm (Pfueller, Lee and
Laing, 2011). It is very important to ensure that there is abundant amount of staff at the
workplace. In case there is lack of staff members it is very difficult task to manage business
operations in proper manner. It can be said that staff is also one of factor that have impact on the
business firm.
TASK 2
2.1 Different type of management accounting information that can be used in the business
Management accounting is widely used to make decisions in the business. There are number of
techniques in management accounting that can be used to measure firm performance. On basis of
5

management accounting information weak spots are identified and corrective steps are taken to improve
performance. Different types of management accounting information that can be used in the business are
given below.
 Budget: It is the statement that is prepared by the business firm and under this cash inflows and
outflows are projected. In this tool planning is prepared about way in which expenditures will be
made in the business. By considering values that are given in the budget expenses are made in the
business and in this way expenses are controlled in the business. There are number of advantage
and disadvantage of using budget for the business firms (Demirović, Simat and Radović,
2014). One of major advantage of using budget is that it help firm in cost control but negative
side is that one need to make estimation of cash flows which may be wrong. This is because one
needs to take percentage to make projection of cash flows. It can be said that budget is the one of
the important tool of making business decision.
 Variance analysis: Variance analysis is another management accounting information that can be
used in the business. Under this method positive or negative performance of the firm is identified
by comparing actual values with budgeted value. If performance is good then in that case then it
is counted as strong point and is considered in strategy formulation. Variance analysis is used to
make decisions in respect to domain which need serious attention from side of management.
 Break even analysis: Break even analysis is the one of the important tool that is used to make
decisions. By using this tool firms determine sales target for their employees and determine that
profit up to specific level will be achieved in the business. In this method it is identified that if all
variable expenses are paid from sales revenue amount then what amount of sales needs to be
made to cover entire cost in the business (Richards, 2017). By using this tool it is determined by
the managers that after paying all expense from sales units to earn determined net profit how
much units extra need to be sold in the market. It can be said that break even analysis is the one
of management accounting information that can be used to make business decisions.
These were the management accounting information that can be used by the firms in their
business because these tools help manager in looking at different directions to improve business
performance. However, they need to ensure that these management accounting tools are used in right way
so that reliable results can be obtained in proper manner. Managers of travel and tourism firm must
cautiously take business decisions in order to solve their problem.
2.2 Assessing the use of investment appraisal techniques as a decision making tool
Investment appraisal techniques include payback period, net present value, average and
internal rate of return. By using techniques of investment appraisal firm can assess the viability
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of proposal and thereby would become able to take suitable decision. Payback period helps
EUROCARIB in identifying the time period within which initial investment will be covered. In
accordance with such technique firm should select project that has less payback period. Net
present value (NPV) is considered as discounted model which in turn helps company in assessing
the return that will be generated after the specific time frame (Moreno-Izquierdo, Ramón-
Rodríguez and Ribes, 2015). Such method offers solution by taking into account the time value
of money concept. Referring the method of NPV, it can be stated that EUROCARIB should
select the proposal that have higher NPV.
Along with this, average rate of return (ARR) method helps in assessing mean return
which will be offered by the concerned proposal. On the basis of such method, project that offers
high average return is highly beneficial over others. In contrast to this, IRR method helps in
assessing return in the form of percentage which is associated with the proposal. In this way,
such discounted method helps EUROCARIB in selecting suitable proposal that aid in the growth
and success. On the basis of cited case situation, firm has different proposal with the same initial
investment and different cash flows. In this regard, by using different techniques business entity
can assess whether proposal is financially viable or not. Options that are available for the
investment purpose are enumerated below:
Calculation of payback period and Net present value (NPV)
Y
ea
r
cash flow
(Project A)
Cumula
tive
cash
inflow
PV
factor
@ 10%
Discoun
ted cash
inflow
cash flow
(Project
B)
Cumulative
cash inflow
Discounted
cash inflow
1 150000 150000 0.909 136364 130000 130000 118182
2 180000 330000 0.826 148760 160000 290000 132231
3 140000 470000 0.751 105184 145000 435000 108941
4 210000 680000 0.683 143433 195000 630000 133188
5 250000 930000 0.621 155230 230000 860000 142812
Total
discounted
cash inflow 688971 635353
Initial
investment 350000 350000
NPV (Total
discounted
cash flow –
338971 285353
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initial
investment)
Payback period
Project A: 2 + (350000 – 330000) / 140000
= 2.1 years
Project B: 2 + (350000 – 290000) / 145000
= 2.4 years
Computation of IRR
Year -350000 -350000
1 150000 130000
2 180000 160000
3 140000 145000
4 210000 195000
5 250000 230000
IRR 40% 35%
Interpretation: The above depicted table shows that payback period of project A and B
accounts are 2.1 & 2.4 years. This aspect shows that project A will offer opportunity to
EUROCARIB to recover initial investment within the suitable time frame. Along with this,
tabular presentation shows that NPV of project A & B accounts for £338971 & £285353
respectively. Further, outcome of investment appraisal shows that IRR of project A & B implies
for 40% and 35% significantly. Thus considering all such aspects and selection criteria it is
advised to EUROCARIB to employ money in option 1 which will prove to be beneficial for it.
TASK 3
3.1 Analysing financial statements of Thomas Cook
Ratio analysis tool is highly prominent that provides assistance in summarizing and
evaluating financial statements of firm. By undertaking such tool business entity or analyst can
measure performance of the firm from various aspects such as profitability, liquidity, solvency,
efficiency and investment. Hence, ratio analysis tool helps in assessing whether performance of
the firm is improved over the time frame or not. In this way, by determining ratios management
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team can take suitable action for improvements (Navickas and Malakauskaite, 2015). Along with
this, it also helps investors in deciding whether they need to invest money in firm’s operations or
not. On the basis of cited case situation, EUROCARIB wants to get information about the
financial aspects of Thomas Cook. In this regard, ratio analysis for the year of 2016 and 2017 is
as follows:
Profitability ratio analysis: It helps in ascertaining the return that is generated by the
firm over expenses including both direct and indirect. Hence, by evaluating profitability aspect
firm can take suitable decision for improvement and enhance its financial position.
Particulars Formula 2016 2017
Gross profit (GP) 1822 1993
Net profit (NP) 12 13
Sales revenue 7812 9007
GP ratio GP / net sales * 100 23.3% 22.1%
NP ratio NP / sales * 100 0.15% 0.14%
2016 2017
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
Profitability ratios
%
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Interpretation: Outcome of profitability ratio analysis clearly shows that GP margin of
Thomas Cook Plc declined from 23.30% to 22.10% in the year of 2017. However, on the other
side, increasing trend is identified in the sales revenue of Thomas Cook Plc from 1822 to 1993
GBP million. Referring such aspect, it can be said that firm’s control on direct expenses is not
good. Due to higher COGS (material, labour), such travel firm fails to attain high margin.
Further, percentage of NP margin shows that profitability margin or position of Thomas Cook
Group Plc is worst. The rationale behind such lower margin is higher operating or indirect and
interest expenses. Thus, for improving such worst position firm is required to undertake the
system of budgetary control which in turn helps in exerting control on both direct as well as
indirect expenses.
Liquidity ratio analysis: This ratio provides deeper insight about the extent to which
firm is financially capable in relation to meeting obligation. Further, quick ratio entails the assets
that can be converted by firm into cash for fulfilling current liabilities such as bank overdraft,
creditors etc (Rajitha and Babu, 2015).
Particulars Formula 2016 2017
Current assets (CA) 2656 2241
Inventory 43 42
Prepaid expenses 401
Quick assets (QA) 2613 1798
Current liabilities (CL) 4630 4325
Current ratio CA / CL 0.57 0.52
Quick ratio QA / CL 0.56 0.42
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2016 2017
0
0.1
0.2
0.3
0.4
0.5
0.6
Liquidity ratios
Interpretation: Graphical presentation depicted above clearly shows that current ratio of
Thomas Cook Group Plc is .57:1 & .52:1 in the year of 2016 and 2017. Such decreasing trend is
not good because as per the ideal ratio for maintaining enough liquidity firms needs to maintain 2
current assets in against to 1 obligation. Thus, considering the present situation it can be stated
that Thomas Cook fails to maintain enough assets in comparison to the level of current
obligations. In contrast to this, in 2016 & 2017, quick ratio of Thomas Cook Plc accounts for .56
& .42 significantly. In accordance with the ideal ratio business unit must have 1 current asset
other than stock and prepaid expenses in comparison to 2 obligations. On the basis of such aspect
quick ratio of the firm is good. However, for enhancing current ratio as well as liquidity position
firm is required to control expenses and focus on maintaining current assets.
Solvency analysis: By doing analysis of such ratio business unit can assess the level to
which financial need is met through the means of debt instrument and equity. Debt-equity ratio is
the most effective measure that helps in identifying whether solvency position of company is
good or not.
Particulars Formula 2016 2017
Long term debt 847 1047
Shareholder’s equity 366 281
Debt-equity ratio Long term debt /
shareholders equity
2.31 3.73
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2016 2017
0
0.5
1
1.5
2
2.5
3
3.5
4
Debt-equity ratio
Debt-equity ratio
Interpretation: Tabular presentation clearly shows that debt-equity ratio of Thomas Cook
Plc is significantly increased from 2.31 to 3.73. Referring such position and comparing the same
with ideal ratio (.5:1), it can be depicted that solvency position of the company is not good. Debt-
equity position clearly exhibits that firm has fulfilled more of its financial needs from debt
sources rather than equity. This is one of the main reasons behind decreasing profitability aspect
of firm. Moreover, loan imposes fixed obligation in front of firm in terms of interest payment
irrespective the aspect that profit is generated by the firm during the year or not. Thus, at the
time of raising fund in the near future firm should lay emphasis on issuing equity shares. By
doing this, Thomas Cook can create optimal capital structure and reduce fixed financial burden.
Investment ratios: Shareholders or investors lay high level of emphasis on analyzing
such ratios before taking investment decision. This measure helps in assessing the return that is
offered by the company to its shareholders in the form of dividend.
Particulars Formula 2016 2017
Earnings per
share
Net income /
number of
shares
outstanding
- 0.01
Dividend per
share
Total
dividends
paid/ number
of shares
- 0.01
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2016 2017
0
0.001
0.002
0.003
0.004
0.005
0.006
0.007
0.008
0.009
0.01
Earnings per share
Dividend per share
Interpretation: Results of financial statement shows that in the year of 2016 earnings and
dividend per share is NIL. Due to the lower income level Thomas Cook failed to offer higher
returns to the shareholders in the form of dividends. In addition to this, in FY 2017, earnings on
per share and dividend which offered by the company to the shareholders was negligible such as
0.01. This in turn places negative impact on the decision making aspect of shareholders. Along
with this, lower return also places negative impact on the brand image of company. Thus, for
offering high return and enhancing brand image Thomas Cook is required making control on
expenses. This in turn helps firm in increasing profit margin to a great extent. Thus, by
developing strategic and competent framework firm can revitalize its image through offering
higher returns to the shareholders.
TASK 4
4.1 Analysing sources of funding that can be obtained by firm for developing new hotel
On the basis of cited case situation, EUROCARIB is planning to establish new hotel in
Carribbean. Usually, such tour firm hires hotel for its tourists regarding the trips which are
planning it. Now, with the motive to explore business operations and establish hotel firm
requires £25 million that is large investment. In this regard, by using internal and external
financial sources firm can meet monetary requirements to the significant level. Hence, sources of
funding which are available to EUROCARIB are enumerated below:
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Internal sources of finance: It implies for the financial sources and options which area
available within the organization. Hence, main internal sources that can be used by
EUROCARIB are as follows:
 Retained profit: For meeting contingent situations business unit lays high level of
emphasis on retaining some amount of profit with itself. It is one of the most effectual
sources that assist in meeting financial needs without any fixed obligations such as
interest etc. Thus, considering such source EUROCARIB can generate funds. However,
such financial source imposes opportunity cost in front of firm. Moreover, when firm
uses retained profit then it is not able to offer dividend to the shareholders. Thus, by
considering all such aspects firm should select the extent to which retained profit needs to
be used.
External financial sources: Funding options that are available outside the business
organization are considered as external. Thus, main external financing options which are
available to such travel firm are:
 Bank loan: EUROCARIB travel firm can raise funds by approaching to the financial
institution on the basis of collateral security. Such source of finance is prominent because
banks are usually ready to give secured loan. Along with this, bank loan financial source
helps company in gaining benefits in tax brackets. Further, it also offers high level of
convenience to the borrower in terms of instalment payment system (Srinivasan, 2016).
However, sometimes bank do not grant whole amount of loan for which firm has applied.
Along with this, interest which is charged banking institution also imposes high cost in
front of firm.
 Issuance of shares: By issuing shares to both existing and potential shareholders firm
can enhance funds. Usually, investors prefer to invest money in the company which
offers high return to the shareholders (Robinson and et.al., 2016). Thus, through issuing
shares EUROCARIB can generate funds and become able to construct hotel unit. In this,
firm offers dividend to the shareholders only when it earns enough profit. However, on
the critical note, when firm meets its financial requirements though the means of equity
then it loses its control from operations.
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Hence, considering all such aspects it can be said that firm should undertake all the above
depicted sources for meeting financial needs. By using retained profit, bank loan and share
capital source EUROCARIB can develop high optimal capital structure. Moreover, suitable debt-
equity mix helps company in balancing the level of expenses. The rationale behind this, in the
case of high debt firm has to make payment of interest. Thus, by taking resort of all such sources
it can be presented that EUROCARIB can establish hotel for offering quality services to the
customers.
CONCLUSION
From the above report, it has been concluded that CVP analysis is highly significant
which in turn helps in making optimum use of financial resources. It can be seen in the report
that such travel or tour firm can set suitable prices for the trip through the means of either
penetration or marginal method. Further, it has been articulated that there are several factors that
has impact on profit margin such as seasonal variations, changing customer’s preferences etc. It
can be summarized from the report that by evaluating or analyzing financial statements
EUROCARIB can develop suitable strategic and policy framework. Besides this, it can be
inferred that by using techniques of investment appraisal business unit can assess the viability of
proposal and would become able to take suitable decisions. Along with this, it can be stated that
financial position and performance of Thomas Cook is not good. Thus, business unit is required
to develop strategic and competent framework firm can improve its financial performance to a
great extent. It can be presented that through using both equity and bank loan sources
EUROCARIB can develop optimal capital structure.
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