The trade-off theory and the pecking order theory suggest a negative relation between leverage and business risk. However, supported by literature [Bennet and Donelly (1993), Huang and Song (2003), Booth et al. (2001), and Deemosak et al. (2004)] the results presented display a strong and significant positive relation between them for all the measures of leverage. This relation can be justified by suggesting that risky firms will tend to use more debt since they cannot transfer wealth from bondholders to shareholders (Bennet and Donelly, 1993) or that firms with risky investments will use higher levels of debt (Huang and Song, 2003). Additionally, a firm can increase its levels of risky investment if the costs and risk of entering into a liquidation process is low (Deemosak et al., 2004). As the Latin American firms volatility of earnings increases, they tend to rely in debt for their future investments.
Focusing to the models including macroeconomic indicators (columns market as II) it can be seen that inflation has a strong and significant positive relation with leverage. The results, though, contradict with literature [Booth et al. (2001), Barbosa and Moraes (2003) and Jorgensen and Terra (2003)]. Latin American countries have experienced high rates of inflation at the end of the 1990’s; however, since 1995, inflation has been decreasing. Despite the latter, internal and external financial crisis has led inflation to rise again at the end of 1990’s and at the beginning of 2000. The results suggest that Latin American firms increase their debt levels when inflation rises because in inflationary periods nominal liabilities, such as debt, depreciate in value, thus, become more attractive to the borrower. The ratio of stock market capitalization to GDP has a negative relation with all the dependent variables, as the capital market develop become a viable alternative; firms will tend to use less debt. On the other hand, the ratio of deposit money bank to GDP displays a positive relation with leverage - as the banking sector increases, firms will have more incentive to use more debt. For both variables, the results concur with Booth et al. (2001) and with Agarwal and Mohatadi (2004).
Booth et al. (2001) argue that higher economic growth tends to increase debt ratios, however, the results illustrate that in Latin American countries economic growth is negatively related with leverage (except for the long-term debt ratio indicating that firms will choose low debt levels during expansion in the business cycle).
Balance sheet lists assets, liabilities and owner’s equity. The assets listed on the balance sheet are acquired either by debt (liabilities) or equity. “Companies that use more debt than equity to finance assets have a high leverage ratio and an aggressive capital structure. A company that pays for assets with more equity than debt has a low leverage ratio and a conservative capital structure. That said, a high leverage ratio and/or an aggressive capital structure can also lead
Target Corporation: Report on Long-term Financing Policy and Capital Structure with an Acquisition Analysis Introduction This report will be based on the Target Corporation, and will consist of two sections: 1) long-term financing policy and capital structure, and 2) an acquisition analysis. The first section will include: Target's most recent long-term financing decision; an analysis of the economic, business, and competitive background in which the financing occurred; Target's book value and market value; possible changes that would occur to Target's finance policy and capital structure if it was forced to consider re-organization and bankruptcy strategies; and finally discuss Target's international investment and financing opportunities, as well as foreign exchange risks. The second section will be a report to the board of directors that identifies a synergistic acquisition candidate for Target.
Mexico was one of Citibank's main emerging market customer bases in the early 1990s. After a very rocky relationship through the 1980s, when Mexico's government declared an inability to pay its foreign commercial bank debt, including more than $US 3 billion owed to Citibank, the country had finally returned to a positive growth path and was delivering solid profits to Citibank in both corporate/institutional banking and retail banking. Mexico's economy grew at an annual rate of more than 5% during the 1990-1994 periods. However, the problems of an overvalued currency, heavy inflow of financial investments into high-yield Mexican securities, and political events in 1994 produced a dramatic decline of confidence in Mexico. Mexican and foreign investors saw the January uprising in Chiapas against M...
The consistent high spending of capital equipment is the first reason why one would recommend reducing the debt to equity ratio. A company with higher levels of debt is less flexible in being able to adjust to new market demands and conditions that require the company to make new products or respond to competition. Looking at the pecking order of financing, issuing new shares to fund capital investing is the last resort and a company that has high levels of debt, must move to the equity side to avoid the risk of bankruptcy. Defaulting on loans occur when increased costs or bad economic conditions lead the firm to have lower net income than the payments on loans. The risk of defaulting on loans and the direct and indirect cost related to defaulting lead firms to prefer lower levels of debt. The financial distress caused by additional leverage can lead to lower cash flows available to all investors, lower than if the firm was financed by equity only. Additionally, the high debt ratio that Du Pont incurred also led to them dropping from a AAA bond rating to a AA bond Rating. Although the likelihood of not being able to acquire loans would be minimal, there are increased interest costs with having a lower bond rating. The lower bond rating signals to investors that the firm is more likely to default than if it had a higher (AAA) bond rating.
All but four countries in the world has external debt (“Country Comparison: Debt External”). Having a debt is almost as common as having a mortgage. Since its establishment, The United States has always been in debt (“Historical Debt Outstanding – Annual”). The US national debt has had five sharp increases previously in its history. The reasons include civil car and the two World W...
Modigliani & Miller applied their theories with two modules, one which doesn’t include the taxes and this is their first finding, and another one with taxes to make it more realistic. The First Proposition without taxes: In this part Modigliani & Miller stated that the firm’s value is not affected by the structure of the capital between Equity and Debt, They proved this by having an example of two firms that have got the same conditions in everything, same cash flow, same operational risks and same opportunity costs. One of the firm’s capital structure is all equity and the other firm’s capital structure is a mixture between equity and debt, since the form of financing (debt or equity) can neither change the firm’s net operating income nor its operating risk, the values of levered and unlevered firms will be the same. They have concluded that the value of the levered firm = the value of the unlevered firm, only if they have the same conditions, same risk levels, cash and opportunity cost.
When starting a business an important question arises, how to finance the company. The steady economic growth combined with low interest rates has produced a lot of liquidity in debt and equity markets. For example, in 2005, non-financial corporate business borrowing increased dramatically to $289 billion, compared to the mere $174 billion it was in 2004 and the $85 billion it was in 2003 (Chung). The outcome of using only debt financing or only equity financing is mostly direct. Businesses run ino the issue when a company’s finance requires both debt and equity characteristics, changing the tax effects greatly (Hanke).
The Web. 11 Mar. 2014. The 'Standard' of the 'Standard'. http://policydialogue.org/files/publications/The_Latin_American_Debt_Crisis_in_Historical_Perspective_Jos_Antonio_Ocampo.pdf>. Pastor, Manuel, Jr. "Latin America, the Debt Crisis, and the International Monetary Fund.
Higher leverage is very likely to create value for a firm considering capital structure change by exerting financial discipline and more efficient corporate strategy changes.
Finding the perfect capital structure in terms of risk and reward can ensure a company meets shareholder expectations and protects a firm in times of recession. Capital structure refers to how a business puts its money to “work”. The two forms of capital structure are equity capital and debt capital. Both have their benefits and limitations. Striking that perfect balance between the two can mean the difference between thriving versus trying to survive.
Declining stock prices affect firms in several ways. First, lower stock prices, especially induced by profit warnings, increase shareholder pressure on managers to cut costs by laying off workers and scaling back investment. Second, the recent correction has put many stock options underwater, and it is unclear to what extent workers will bargain for more cash in place of options and how this might affect payroll costs and inflation. Third, the factors dragging down stock prices typically spur investors to demand higher risk premiums, which boosts the cost of financing business investment. This takes the form of increased spreads of corporate bond and commercial paper interest rates relative to Treasury yields and lower prices for any new stock that any firm dares to offer. Aside from raising the going price of new finance, the increased uncertainty associated with lower stock prices can spook investors so much, that the availability of finance is reduced. Since the...
What do you understand by the phrase “stakeholder analysis”? Attempt a stakeholder analysis of an organisation that you are closely associated with.
Managers are encouraged to act more in the interest of shareholders and the amount of leverage in the capital structure affects firm profitability (Ebaid, 2009).
Debt crisis is becoming common and faced by most citizens in Malaysia. Between June 1997 and January 1998 a financial crisis swept like a brush fire through the "tiger economies" of SE Asian. Over the previous decade the SE Asian states of Thailand, Malaysia, Singapore, Indonesia, Hong Kong, and South Korea, had registered some of the most impressive economic growth rates in the world. Their economies had expanded by 6% to 9% per annum compounded, as measured by Gross Domestic Product. This Asian miracle, however, appeared to come to an sudden end in late 1997 when in one country after another, local stock markets and currency markets imploded. When the dust started to settle in January 1998 the stock markets in many of these states had lost over 70% of their value, their currencies had depreciated against the US dollar by a similar amount, and the once proud leaders of these nations had been forced to go cap in hand to the International Monetary Fund (IMF) to beg for a massive financial assistance. (W.L.Hill, n.d.)
During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis’s cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task.