Capital structure case study. Capital structure 2022-10-09
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Capital structure refers to the mix of a company's long-term financing sources, such as debt, preferred stock, and common stock. The optimal capital structure is the one that maximizes a company's value while minimizing its cost of capital. In this essay, we will conduct a case study of XYZ Company, a fictional firm, to understand the factors that influence its capital structure and the trade-offs it faces when deciding on the optimal mix of financing sources.
XYZ Company is a mid-sized manufacturing firm that has been in business for over 50 years. It has a stable customer base and a solid track record of profitability. However, like all companies, XYZ faces the challenge of financing its operations and growth.
One factor that influences XYZ's capital structure is the nature of its business. If the company operates in a highly cyclical industry or has a significant amount of intangible assets, it may be perceived as a higher risk by lenders and investors. In such cases, the company may need to rely more on equity financing to compensate for the perceived risk. On the other hand, if the company has a stable revenue stream and tangible assets that can be used as collateral, it may be able to access more debt financing at lower costs.
Another factor that affects XYZ's capital structure is its growth prospects. If the company has a strong growth potential, it may be able to attract more equity financing, as investors are willing to take on higher risk in exchange for the potential of higher returns. On the other hand, if the company's growth prospects are limited, it may need to rely more on debt financing, as investors may be less willing to provide capital without the promise of higher returns.
In addition to these factors, XYZ's capital structure is also influenced by its financial performance and creditworthiness. If the company has strong financials and a good credit rating, it may be able to access debt financing at lower interest rates. This can be beneficial for the company, as it can reduce the cost of financing its operations and growth. However, if the company has weak financials or a poor credit rating, it may need to rely more on equity financing, which can dilute the ownership stake of the existing shareholders.
There are several trade-offs that XYZ must consider when deciding on its capital structure. One trade-off is between the cost of capital and the risk of financial distress. Debt financing typically has a lower cost of capital compared to equity financing, but it also introduces the risk of financial distress if the company is unable to make its debt payments. On the other hand, equity financing does not have this risk, but it can dilute the ownership stake of the existing shareholders and may not be as readily available as debt financing.
Another trade-off that XYZ must consider is between the tax benefits of debt financing and the potential negative impact on the company's credit rating. Debt financing can provide tax benefits, as the interest payments on the debt are tax-deductible. However, if the company has a high debt-to-equity ratio, it may be perceived as a higher risk by lenders and investors, which can lead to higher borrowing costs or a lower credit rating.
In conclusion, the capital structure of a company is influenced by a variety of factors, including the nature of the business, growth prospects, financial performance, and creditworthiness. Deciding on the optimal capital structure involves trade-offs between the cost of capital, the risk of financial distress, and the tax benefits of debt financing. By carefully weighing these trade-offs, XYZ Company can make informed decisions about its capital structure that will maximize its value and minimize its cost of capital.
Free Case Study on Capital Structure
However, when more than one few companies uses the same resources and provide competitive parity are also known as rare resources. Debt is utilized for its tax savings ability in that the firm's interest payments to holders of its debt are a reduction from profit before tax. This is indicated by the following dividend per share declared and paid between 2006 and 2011 as shown below Mandarin Oriental the Hotel Group, 2011. We do not believe that it is a reasonable trade-off. For all the three companies, the analysis is done for the period between 2006 and 2011. Therefore, in order to diversify and grow its portfolio, the company must persistently raise capital Byoun, 2008.
Tax bracket of 44% is used based on ratio of income taxes to income before income taxes 175. However, it is also to be taken into account that debt is considered to be more risky than equity because of the risk of bankruptcy and other financial distress costs. Capital Structure Case Study Solution - Star Star is a company which has recently been listed on the Alternative Investment Market. The decision that is being taken should be justified and viable for solving the problems. Furthermore, management's style of leadership is not jeapordized with the recommended lower portion of debt because it follows the company's historical capital structure. Any firm who has valuable and rare resources, and these resources are costly to imitate, have achieved their competitive advantage.
Bed Bath and Beyond: The Capital Structure Decision Case Study Solution and Case Analysis
According to the 2009 annual report of the company, British Airways is expected to have 35% market share in the EU airline market and 21% in US market British Airways, 2009. The Accounting Review, 48 2 , 339-352. How much financial risk would BBBY face at each proposed levels of debt? The Journal of Finance, 55, 1901-1941. It provides one with the capital to expand his assets without giving away the ownership of the business. Brushing up HBR fundamentals will provide a strong base for investigative reading.
Less debt makes AHP less reliant on the need for growing revenues or sales, because of its lack of financial obligations. For example, if a firm is known to have financed 70% of its assets using debt and 30% using equity then the company is said to have a leverage of 70%. STEP 9: Selection Of Alternatives For Optimal Capital Structure Case Solution: It is very important to select the alternatives and then evaluate the best one as the company have limited choices and constraints. Viewed on 15th October 2013 Richards, Daniels. Operating leases are in essence as long term liability for the company. The reasons that resource imitation is costly are historical conditions, casual ambiguity and social complexity. At very high gearing the cost of debts also rises since the risk of the company defaulting on the debt rises in tandem, meaning that at higher gearing, the WAAC will increase.
Journal of Financial Economics, 76 1 , 549-582. By holding debt capital, the company is liable to pay high interest expenses. The leverage of eBay is more than the other online auctioneers. In the balance sheet, these figures will be regarded as long term liabilities. Both paying dividends and repurchasing shares reduces Wrigley's equity.
The Capital Structure Decision and the Cost of Capital
Long-term financing policies The ability of the company to raise long-term capital relies on external factors, including conditions of credit and equity markets, the situation of the tenants as dictated by the industry, and generally the performance of real estate venture trusts. Laporte's unique brand of management and company control, we believe that the primary argument for maintaining a 30% debt ratio is the threat of corporate takeover via a leveraged buyout. The author of this theory suggests that firm must be valuable, rare, imperfectly imitable and perfectly non sustainable. Organizations are entities that are not any different from an analysis point of view than that of actual Marriott Corporation Case Study 1050 Words 5 Pages Weighted average cost of capital for Marriot Corporation: In order to determine cost of capital, first we need to find out cost of equity and cost of debt. In the light of this fact, the investments into the airline industry grew by 49% between 1980 and 2007 Zinnov, 2007; Brogden, 2009.
Capital Structure Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies
Be very slow with this process as rushing through it leads to missing key details. A student should study the capital structure of the chosen company and find out enough data to present the cause and effect sides of the problem and prepare a sensible paper. The WACC should include the types of capital used to pay for long-term assets like as long-term debt, preferred stock and common stock. How would you characterize the business risk of BBBY? From 2010-2021, the equity multiplier decreased about four times from an average of 3. If the goods and services are not up to the standard, consumers can use substitutes and alternatives that do not need any extra effort and do not make a major difference. A method of corporate takeover or merger popularized in the 1980s, leveraged buyouts involved the purchase of controlling interest in a company's corporate stock with a substantial fraction of borrowed funds financed with the takeover company's assets. Order custom essay Products Capital Structure Case Study with free plagiarism report In general, the lower the company's reliance on debt for asset formation, the less risky the company is since excessive debt can lead to a very heavy interest and principal repayment burden.
What does the balance sheet look like after adjusting for operating leases? The cost of capital for eBay is around 10. For example, using Aquafina in substitution of tap water, Pepsi in alternative of Coca Cola. This is just a sample partial case solution. The analysis of this company reveal that it is draws it financing from loans and equity. Working capital management practices The company provides operating capital to facilitate operation of the property, including payment of wages, property taxes, utilities, among other expenses, as well as purchase of inventory.
According to the information provided by exhibit 3 equity beta is estimated at 0. However, as the gearing rises, the effects of the financial leverage cause shareholders to increase their expected rates of returns. Leverage: Good or Bad? The annual revenue of the company grows regularly; this allows the British Airways to earn £8. It is important to notice that in 2008 the cost of debt fell by only 0. This proposition assumes that the assets and growth opportunities on the left hand side of the balance sheet have been held at a constant. The company being in grocery and consumer products business does not have the operating margin as high as eBay. Recently, the Company directly acquired 23 hotels through its own joint ventures.
The next step is organizing the solution based on the requirement of the case. Leary 37 has pointed out that the impacts and implications of the capital structure of the firms, as eeither bank or non bank dependent, to be influenced by the relationship between the interest rates and the debt sources or debt issuance timing. Often history is provided in the case not only to provide a background to the problem but also provide the scope of the solution that you can write for the case study. Introduction The theories of capital structure attempts to provide an explanation between the mix of securities and financing sources that may be employed by corporations to finance their real investments. This can be best achieved by adjusting the debt financing upwards to cushion the company form effects of tax deductions due to its large size. In this module, the concept of capital structure was discussed. The milestone theory of capital structure was formed by Modigliani and Miller in 1958 Brigham, 2007, p.