Checklist for Capital Structure Decisions

What Optimal Capital Structure

Firms generally consider the following factors when making capital structure decisions 1. Sales stability. A firm whose sales are relatively stable can safely take on more debt and incur higher fixed charges than a company with unstable sales. Utility companies, because of their stable demand, have historically been able to use more financial leverage than industrial firms. 2. Asset structure. Firms whose assets are suitable as security for loans tend to use debt rather heavily. General-purpose...

Four Mistakes to Avoid

We often see managers and students make the following mistakes when estimating the cost of capital. Although we have discussed these errors previously at separate places in the chapter, they are worth repeating here 1. Never use the coupon rate on a firm's existing debt as the pre-tax cost of debt. The relevant pre-tax cost of debt is the interest rate the firm would pay if it issued debt today. 2. When estimating the market risk premium for the CAPM method, never use the historical average...

Using Debt Financing to Constrain Managers

Agency problems may arise if managers and shareholders have different objectives. Such conflicts are particularly likely when the firm's managers have too much cash at their disposal. Managers often use excess cash to finance pet projects or for perquisites such as nicer offices, corporate jets, and sky boxes at sports arenas, all of which may do little to maximize stock prices. Even worse, managers might be tempted to pay too much for an acquisition, something that could cost shareholders...

Valuing Stocks That Have a Nonconstant Growth Rate

Dividend Non Constant Growth Model

For many companies, it is inappropriate to assume that dividends will grow at a constant rate. Firms typically go through life cycles. During the early part of their lives, their growth is much faster than that of the economy as a whole then they match the economy's growth and finally their growth is slower than that of the economy.11 Automobile manufacturers in the 1920s, computer software firms such as Microsoft in the 1990s, and Internet firms such as AOL in the 2000s are examples of firms...

Conclusions on Stock Repurchases

When all the pros and cons on stock repurchases have been totaled, where do we stand Our conclusions may be summarized as follows 1. Because of the lower capital gains tax rate and the deferred tax on capital gains, repurchases have a significant tax advantage over dividends as a way to distribute income to stockholders. This advantage is reinforced by the fact that repurchases provide cash to stockholders who want cash while allowing those who do not need current cash to delay its receipt. On...

Spreadsheet Problem

BUILD A MODEL FORECASTING FINANCIAL STATEMENTS Start with the partial model in the file Ch 11 P10 Build a Model.xls from the textbook's web site. Cumberland Industries' financial planners must forecast the company's financial results for the coming year. The forecast will be based on the percent of sales method, and any additional funds needed will be obtained by using a mix of notes payable, long-term debt, and common stock. No preferred stock will be issued. Data for the problem, including...

Calculate Brauer S Profit Margin And Debt Ratio

Ace Industries has current assets equal to 3 million. The company's current ratio is 1.5, and its quick ratio is 1.0. What is the firm's level of current liabilities What is the firm's level of inventories Baker Brothers has a DSO of 40 days. The company's average daily sales are 20,000. What is the level of its accounts receivable Assume there are 365 days in a year. Bartley Barstools has an equity multiplier of 2.4. The company's assets are financed with some combination of long-term debt and...

Effects of Dividend Policy on rs

The effects of dividend policy on rs may be considered in terms of four factors (1) stockholders' desire for current versus future income, (2) perceived riskiness of dividends versus capital gains, (3) the tax advantage of capital gains over dividends, and (4) the information content of dividends (signaling). Since we discussed each of these factors in detail earlier, we need only note here that the importance of each factor in terms of its effect on rs varies from firm to firm depending on the...