Executive Summary
DuPont has been known for its low reliance on borrowings. In the 1970’s, the company had to assume a substantial portion of debt of Conoco, a newly acquired company. In 1983, the managers have to decide about the future optimal target debt ratio. Should the company continue to keep about 40% of its assets financed via debt or should it strive to lower its borrowings to 25%?
We defined several criteria to determine our choice – return, risks and other quantitative and qualitative factors. Targeting a debt ratio of 40% will maximize the firm’s value. A higher earning’s per share and dividends per share will lead to a higher stock price in the future. Due to leveraging, return on equity is higher because debt is the major source of financing capital expenditures. To maintain the 40% debt ratio, no equity issues will be declared until 1985. DuPont will be financing the needed funds by debt. For 1986 onwards, minimum equity funds will be issued. It will be timed to take advantage of favorable market condition. The rest of the financing required will be acquired by issuing debt.
Case Context
DuPont is a very big company with a low debt policy designed to maximize financial flexibility and insulate operations from financial constraints. It is one of the few AAA rated manufacturing companies due its investments are primarily financed from internal sources. However, because prices fell in the 1960’s thus DuPont’s net income fell also. The adverse economic conditions in 1970’s escalated inflation: increase in oil prices increased required inventory investments of the company. 1975 recession negatively affected DuPont’s net income by 33% and returns on capital and earnings per share fell. The company cut dividends in 1974 and working capital investment removed. Proportion of debt increased from 7% in 1972 to 27% in 1975 and interest coverage falls from 38 to 4.6. The company perceived increase in debt temporary but moved quickly to reduce its debt ratio by decreasing capital expenditures. Debt proportion dropped to 20%, interest coverage increased to 11.5 by 1979.
In 1981, DuPont issued $3.9 Billion in common stocks, $3.85 billion in debt and assumed $1.9 billion of Conoco debt to acquire Conoco. DuPont debt ratio increases to 42%, interest coverage to 5.5 and ratings went down to AA.
In 1982, merger with Conoco exhibited poor performance. DuPont also lowered debt ratio to 36% due to asset sales, but interest coverage lowered to 4.
These ratios can be used to determine the most desirable company to grant a loan to between Wendy’s and Bob Evans. Wendy’s has a debt to assets ratio of 34.93% while Bob Evans is 43.68%. When it comes to debt to asset ratios, the company with the lower percentage has the lowest risk. Therefore, Wendy’s is more desirable than Bob Evans. In the area of debt to equity ratios, Wendy’s comes in at 84.31% while Bob Evans comes in at 118.71%. Like debt to assets, a low debt to equity ratio indicates less risk in a company. Again, Wendy’s is the less risky company. Finally, Wendy’s has a times interest earned ratio of 4.86 while Bob Evans owns a 3.78. Unlike the previous two ratios, times interest earned ratio is measured on a scale of 1 to 5. The closer the ratio is to 5, the less risky a company is. From the view of a banker, any ratio over 2.5 is an acceptable risk. Both companies are an acceptable risk, however, Wendy’s is once again more desirable. Based on these findings, Wendy’s is the better choice for banks to loan money to because of the lower level of
In SIVMED’s case, based on the definition of WACC, all capital bases should be included in its WACC. These include its common stock, preferred stock, bonds and long-term borrowings. In addition to being able to compute for the costs of capital, the WACC also determines how much interest SIVMED has to pay for all its activities. The value of the firm’s stock, which we want to maximize, depends of the after-tax cash flow. Hence, after-tax values for WACC are also needed. Furthermore, cost of capital is used to determine the cost of each debt, stock or common equity. Being able to analyze these will be essential into deciding what and how new capital should be acquired. Hence, the present marginal costs are ideally more essential than historical costs.
When comparing the debt-to-assets ratio of McDonalds and Wendys, you have to divide the firms total liabilities by their total assets. Essentially, the debt-to-assets ratio is the primary indicator of the firms debt management. As the ratio increases or decreases, it indicates the firms changing reliance on borrowed resources. The lower the ratio the more efficient the firm will be able to liquidate its assets if operations were discontinued, and debts needed to be collected. In 2005 Wendy's had $2,076,043 worth in total assets and $846,264 in total liabilities. When divided, Wendys has the lower ratio of the two competitors at 40%. This means that they would take losses of 40% if operations were shut down, and the cash received from valuable assets would still be sufficient to pay off the entire debt. It also means that 40% of Wendys assets are made through debt. McDonalds in 2005 had $12,545.3 (in millions) of total liabilities and $22,534.5 (in millions) of total assets. After doing the math, McDonalds ends up with a ratio of 56% which is higher than Wendys by sixteen percent. This means that there is more default on McDonalds liabilities, which can be a costly event from lenders perspective. McDonalds makes 56% of all its assets through debt. In reality, its not good to have a debt-to-assets ratio over 50%. Its also not good to have a debt-to-assets ratio that is too low because...
You would not buy a home, car or other large purchases without researching what product offered you the most for your money. The same is true when investing in a company. Investors do avid research on multiple companies to find what company matches the investors' criteria. In this paper Team C will research both AT&T and Verizon's financial documents. Team C will compare selected ratios, cash flow and make recommendations how both companies can manage cash flow for the future.
Looking at the individual ratios seen in exhibit 1 and comparing it to the industry average shown in exhibit 2 gives a sense of where this company stands. Current ratio and quick ratio are really low and have been decreasing. For 1995, the current ratio is 1.15:1, which is less than the industry average of 1.60:1, however to give a better sense of where this stands in the industry, as seen in exhibit 3, it is actually less than the average of the bottom 25% of the industry. The quick ratio is 0.61 is less than the industry is 0.90. Both these ratios serve to point out the lack of cash in this company. The cash flow has been decreasing because, it takes longer to get the money from customers, but the company still needs to pay for its purchases. Also, the company couldn’t go over the $400,000 loan limit, so they were forced to stretch their cash.
In 1993 the Debt to Equity Ratio was .45. In 1994 it was .68 and in 1995 it was .73. This is a trend that Clarkson will have to take into consideration as he refinances his company.
Based on the information in the case, Pepsi could invest US$360 million in exchange for 30% equity of Deltex. So we have to calculate the value of 30% equity of Deltex. First, we calculated the discount factor by using average unlevered beta of US independent bottlers, US 10 year Treasury bond as risk free rate and assuming market risk premium 10%. We came up with 9.83% of WACC. Next, we calculated Deltex free cash flow and terminal value and then converted them into US dollar value. Now with WACC and total cash flow, we had NPV of the company. So we deducted current debt from NPV and came up with the value of US$360M investment equal to 59.99% of Deltex equity. So the proposal to buy 30% of Deltex with US$360M is too expensive to PepsiCo and not attractive to PepsiCo.
MCI is at a critical point in their company history. After going public in 1972 they experienced several years of operating losses. Then in 1974 the FCC ordered MCI's largest competitor AT&T to supply interconnection to MCI and the rest of the long distance market. With a more even playing field the opportunities to increase market share and revenue were significant. In order to maximize this opportunity MCI required capital. Their poor financial performance required them to use less traditional instruments to obtain financing. The capital acquired supported their growth until they reached a level of profitability in 1978. Subsequently they continued to increase their net income and the quality of their balance sheet. With continued prospects for growth tempered with some regulatory uncertainty they need to determine their optimal financial structure for the future.
2. Given the forecasts provided in the case, estimate the expected incremental free cash flows associated with Du Pont’s growth strategy and maintain strategy for the TiO2 market. How much risk and uncertainty surround these future cash flows? Which strategy looks most attractive (i.e., using the DCF (e.g., NPV) method)??
The Dupont analysis shows that every dollar of assets generates 2.44 in sales which is great considering it was already good in 2014 and 2015 and keeps improving each year, the equity multiplier is 2.516 indicating that ROE is generated through efficient use of equity and leverage of 60% that can be increased slightly to surge ROE.
In assessing Du Pont’s capital structure after the Conoco merger that significantly increased the company’s debt to equity ratio, an analyst must look at all benefits and drawbacks of a high debt ratio. The main reason why Du Pont ended up with a high debt to equity ratio after acquiring Conoco was due to the timing and price at which they bought Conoco. Du Pont ended up buying the firm at its peak, just before coal and oil prices started to fall and at a time when economic recession hurt the chemical industry of Du Pont. The additional response from analysts and Du Pont stockholders also forced Du Pont to think twice about their new expansion. The thought of bringing the debt ratio back to 25% was brought on by the fact that the company saw that high levels of capital spending were vital to the success of the firm and that high debt levels may put them at higher risk for defaulting.
There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than external financing which is due to adverse selection, asymmetry of information, and agency costs (Frank & Goyal, 2003). The trade-off theory comes from the pecking order theory it is an unintentional outcome of companies following the pecking-order theory. This explains that firms strive to achieve an optimal capital structure by using a mixture debt and equity known to act as an advantage leverage. Modigliani and Miller (1958) showed that the decisions firms make when choosing between debt and equity financing has no material effects on the value of the firm or on the cost or availability of capital. They assumed perfect and frictionless capital markets, in which financial innovation would quickly extinguish any deviation from their predicted equilibrium.
In “Bank Debt” alternative, a sum of $3.5 million will be injected to the company through bank loans. However, the company will have to pay an additional amount of $33,750 in interest and a principal payment of $300,000 to the bank annually over the course of 7 years. Net income will come to $489,187.50 and EPS will be 0.49.
Rondo's Current Ratio is a steady at 2.0 compared to the industry average of 1.4. This indicates the company will not have a problem covering its current liabilities. Rondo's quick ratio is also steady at 1.4. The company can cover its short-term debt 1.4 times over without selling off its inventory. Rondo's performance is good in this area.
The capital structure of a firm is the way in which it decides to finance its operations from various funds, comprising debt, such as bonds and outstanding loans, and equity, including stock and retained earnings. In the long term, firms seek to find the optimal debt-equity ratio. This essay will explore the advantages and disadvantages of different capital structure mixes, and consider whether this has any relevance to firm value in theory and in reality.