Question

Corporations in the airline industry tend to have higher debt-to-equity ratios than corporations in the tech industry. Explain why.

Answer 1

Airline industry is highly capital intensive industry & is often considered to have among the highest D/E ratios. The reason being that airlines companies have to purchase planes, pay for fuel, outfit those planes, pay for air hangars, pay for flight simulators, pay for repairs on planes, pay for pilots, flight attendants and baggage handlers, and multitude of other costs. This makes the sector very highly leveraged in terms of fixed costs and to add to it the seasonality of the business means huge risk. Hence, shareholders want higher return to compensate for risk. This increases the cost of equity. As the business model is not risky per se, debt investirs are willng to invest. Hence the companies take on more debt which is cheaper and have high D/E ratios.

On the other hand, tech industry is not very capital intensive but the technology is constantly changing and he nce the business model is very very risky. So debt investors dont want to invest. Hence, the only resort to raising funds is equity despite higher costs.