In January2016,United Airlines (UAL) had a market capitalization of $20.56 billi

Question

In January2016,United Airlines (UAL) had a market capitalization of $20.56 billion, debt of $11.81 billion, and cash of $5.09 billion. United Airlines had revenues of $39.91
billion. Southwest Airlines (LUV) had a market capitalization of $27.35 billion, debt of $3.12billion, cash of $3.03 billion, and revenues of $19.69 billion.
a. Compare the market capitalization-to-revenue ratio (also called the price-to-sales ratio) for United Airlines and Southwest Airlines.
b. Compare the enterprise value-to-revenue ratio for United Airlines and Southwest Airlines.
c. Which of these comparisons is more meaningful? Explain.

Explanation / Answer

a)

Market capitalization to revenue ratio = Market capitalization/Revenues

Market capitalization to revenue ratio of UAL= $20.56 billion /$39.91 billion

                                                                          =51.5159%

Market capitalization to revenue ratio of LUV= 27.35 billion /19.69 billion

                                                                          =138.9030%

b)

Step-1

Value of an enterprise= Market capitalization+Debt-Cash

Value of an UAL= 20.56 billion +11.81 billion -5.09 billion

                            = 27.28 billion

Value of an LUV= 27.35 billion +3.12 billion -3.03 billion

                            = 27.44 billion             

Step-2

Value to revenue ratio= Value of enterprise/Revenue

Value to revenue ratio of UAL= 27.28/39.91

                                                = 68.3538%

Value to revenue ratio of LUV= 27.44/19.69

                                                = 139.3601%

c)

The market capitalization to revenue ratio does calculate the ratio between revenue and value of equity. The enterprise value to revenue is the ratio between total value of the firm and revenue. The change in capital structure of the firm will drastically influence the ratio in the market capitalization to revenue ratio. However, it does not influence in the case of enterprise value to revenue ratio. Therefore, enterprise value to revenue ratio is more meaningful than market capitalization to revenue ratio.

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