The airline industry is one of the more volatile industries. During lean years in the early 1990s.. 1 answer below »

The airline industry is one of the more volatile industries. During lean years in the early 1990s, the industry wiped out the earnings it had reported during its entire history. Pan American Airlines and Eastern Airlines ceased operations, while Continental Airlines, TWA, and US Air filed for bankruptcy protection. The industry bounced back in the mid-1990s, riding on the wings of the U.S. economic prosperity and lower energy prices. The airlines have been especially profitable since 1996, with returns on equity often in excess of 25%. The stock market has recognized the stellar growth in profitability as market capitalization of many airlines has tripled since then. Volatility in airlines earnings arises from a combination of demand volatility, cost structure, and competitive pricing. Air travel demand is cyclical and sensitive to the economy s performance. The cost structure of airlines is dominated by fixed costs, resulting in high operating leverage. While most airlines break even at 60% flight occupancy, deviations from this can send earnings soaring upward or downward. Also, the airline industry is price competitive. Because of their cost structure (low variable but high fixed costs), airlines tend to reduce fares to increase market share during a downturn in demand. These fare reductions often lead to price wars, which reduces average unit revenue. Hence, airfares are positively correlated with volume of demand, resulting in volatile revenues. When this revenue varia

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