Capital Structure and Dividends, Module 4 case 4 capital Structure help

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Question Description

This assignment consist of Word memo and excel.  TURNIT IN IS USED FOR GRADING

 

 

Module 4 - Case

Capital Structure and Dividends

Case Assignment

Analyzing a Firm’s Capital Structure

Mr. Hillbrandt has learned a lot about the financial side of running the business during the first year with the company and is now contemplating making changes to the corporate capital structure. He needs your assistance one more time.

ABC Golf Equipment Corporation has $10 million in assets (where the market value of the assets is equal to the book value of the assets) and no debt.  The company’s marginal tax rate is currently 35% and has 500,000 shares outstanding.  The company’s earnings before interest and taxes (EBIT) are $3.88 million.  The firm’s stock price is $27 per share and the cost of equity is 11%.

The company is thinking of issuing bonds and simultaneously repurchasing a portion of its stock.  If the company changes its capital structure from no debt to 25% debt based on market values, the firm’s cost of equity will increase to 13% because of the increased risk.  The bonds can be sold at a cost of 9%.  The firm’s earnings are not expected to grow over time.  All of its earnings will be paid out as dividends.  

Probability

EBIT ($)

0.05

- 1 million

0.25

2.3 million

0.40

4 million

0.25

5.8 million

0.05

6.1 million

Required:

Computations (use Excel).

Make the computations necessary to answer the questions below. Don’t forget that Mr. Hillbrandt does appreciate your step-by-step computations to guide him through the analysis. 

  1. What impact will this utilization of this debt have on the value of the company?
  2. What’s going to be the company’s EPS after the recapitalization?
  3. What’s going to be the company’s new stock price?
  4. The $3.88 million EBIT discussed above is determined from this probability distribution.
  5. What’s the times interest earned ratio at each probability level?

Memo (use Word).

Interpret the analysis already prepared and use the Excel computations as a basis for a memo to the CEO. Write a four or five paragraph memo. Make sure each question listed above is addressed. Start with an introduction and end with a recommendation. Each of the four or five paragraphs should have a heading.

Short Essay (use Word).

Do research to determinesome significant considerations that go intoselecting or changing the capital structure of a corporation.Start with an introduction and end with a summary or conclusion. Use headings. Don’t forget to reference your sources. Maximum length of two pages.

Assignment Expectations

Each submission should include two files: (1) An Excel file; and (2) A Word document. The Word document shows the memo first and short essay last. Assume a knowledgeable business audience and use required format and length. Individuals in business are busy and want information presented in an organized and concise manner.

 

 

 

 

 

 

Module 4 - Background

Capital Structure and Dividends

Capital Structure and Dividend Policy Podcast. (2014). Pearson Learning Solutions, New York, NY.

Capital Structure and Dividend Policy Interactive Video. (2014).  Pearson Learning Solutions, New York, NY.

Review these website links:

Damodaran, A. (2005). Finding the right financing mix: The capital structure decision. Retrieved June 2014 from http://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/capstr.pdf

Harvey, C. (1995). WWWFinance: capital structure and payout policies. Retrieved June 2014 from http://www.duke.edu/~charvey/Classes/ba350/capstruc/capstruc.htm

Peavler, R. (2012). Debt and equity financing. Retrieved June 2014 from http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm

There are advantages and disadvantages to having debt in a corporation’s capital structure.

Corporations get a tax deduction  from the interest paid on debt.  On the other hand, dividends are not tax deductible.  This helps to reduce the cost of debt since the after-tax cost of debt is used in the weighted average cost of capital and not the pre-tax cost of debt.  The cost of equity is usually much higher and can be estimated through the Capital Asset Pricing Model (CAPM).  If a firm is very successful, the stockholders don’t have to share the profits with debtholders since the return on debt is not a variable. 

There are some problems with debt, though.  As a company uses more debt in its capital structure, it increases the company’s risk.  This increases the costs of equity and debt.  If a company has financial problems and can’t cover its interest charges, the firm may have to go bankrupt if it can’t obtain additional financing. 

Firms that have quite variable earnings and operating cash flows are better off having limited debt in their capital structures.  Companies with more stable earnings and operating cash flows can utilize more debt in their capital structures. 

Business risk is probably the most important factor that drives capital structure decisions.  Business risk is the riskiness of a company’s operations if it doesn’t utilize debt.  Financial risk is the increased shareholders’ risk from the use of debt in the capital structure.  There’s no set optimal capital structure for all firms. 

An investor’s total return consists of the capital gains yield and the dividend yield.  Not all companies pay dividends; however, for those that do, it is an important component of an investor’s return, particularly for those seeking income.  Individuals who are retired are usually the clientele most interested in dividends.  If a stock’s price didn’t change all year, yet the company paid a healthy dividend yield, the investor would still earn a positive total return. 

Successful companies typically accumulate a large amount of cash on their balance sheet.  If the company has funded all the positive NPV projects that it wants to, it can look to paying a dividend or buying back stock.  If it currently already pays a dividend, it can look to increase the dividend. 

A company that increases its dividend or institutes a dividend provides a signal to the marketplace that it anticipates higher future cash flows at the firm since once a company increases or starts a dividend it rarely reduces or eliminates the dividend.  On the other hand, a company that decreases its dividend or eliminates a dividend provides a signal to the marketplace that it anticipates lower future cash flows at the firm. 

Optional Resources

Bookboon.com. (2008). Corporate Finance. Retrieved from http://bookboon.com/en/economics-and-finance-ebooks

Welch, Ivo. (2014). Corporate Finance (3rd Ed.). Chpts 16 and 19. Retrieved from http://book.ivo-welch.info/ed3/toc.html

Tutor Answer

Ace_Tutor
School: UT Austin

attached is my answer

Memo
Question 1:
Impact on firm's value involves that organization's capital structure is conditioned by
the extent of its borrowings to value, the debt-equity proportion, coming about because of
earlier financing choices. This refers to the correct hand side of the accounting report which
mirrors the left-hand side and along these lines the advantages coming about because of
earlier venture choices. So as to look at how a value of the firm is influenced by changing the
measure of use, just capital restructurings are considered while the left-hand side stays
consistent.
Debt introduction in ABC Golf Equipment Corporation capital structure has raised
firm's WACC from 11% to 11.21% which has come about abatement in the estimation of the
firm by $ 434,519. Henceforth it is suggested that debt should not be presented in capital
structure due to increment in WACC because of money related misery.
Question 2:
Earnings per share (EPS) refer to the portion of an organization's benefit dispensed to
each extraordinary offer of basic stock. EPS fills in as a pointer of an organization's benefit.
While computing, it is more exact to utilize a weighted normal number of offers remarkable
over the detailing term, due to the fact that the number of offers can change after some time.
In any case, information sources now and then improve the count by utilizing the number of
offers toward the finish of the period.
In terms of impact on firm after recapitalization, according to the calculated
worksheet, the company’s EPS has already raised from $ 5.04 per share to $ 6.20 per share

due to the buyback of 125000 shares and additionally because of tax saving applied on
interest derived from the new debt.
Question 3:
Stock price refers to the price of obtaining a security on a trade. Stock prices can be
influenced by various things incorporating instability in the market, current monetary
conditions, and notoriety of the organization. The speculator was watchful when acquiring
stock in the organization, as the stock cost was known to vary significantly in this particular
market. Stock p...

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