case study on capital structure with solution

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case study on capital structure

how company face the problem of fund arrangement and how overcame it

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Economics and Applied Informatics, 2014

The changes in capital structure and in financial components of a company have a particular importance in choosing optimal financing decision, in determining the impact of changes in capital structure and of elements within balance sheet. To quantify such an impact in the literature have been considered many factors as debt-equity ratio, profitability, self financing capacity and the ability to earn profit. Using the comparative method over a period of three years to five companies acting in the metallurgical sector in this paper has been analyzed the evolution of debt capacity ratio, return on equity ratio, financial long term debt ratio, interest coverage ratio and long-term financial autonomy ratio. Based on these findings it was concluded that the variation of capital structure and performance of the companies affects and influences funding arrangements considered by the companies’ managers

Capital structure is the mixture of debt and equity financing. Its choice and determinants related to many different factors. This thesis firstly present several traditional theories discussed on capital structure, such as trade-off theory, agency cost theory and theory of pecking-order. Then the paper concluded seven determined factors from practical aspects and discussed on the correlations among these factors and the choice of capital structure.

Capital structure decision poses a lot of challenges to firms. Determining an appropriate mix of equity and debt is one of the most strategic decisions public interest entities are confronted with. A wrong financing decision has the tendency of stalling the fortunes of any business. Therefore, if managers are to achieve the goal of wealth maximization, conscious steps must be taken in the right direction and at the right time to identify those factors that must be taken into cognizance in determining appropriate financing mix. It is upon this premise that this conceptual piece is designed to guide the top echelons of corporate managers in capital structure decisions. The paper explores a vast body of literature in articulating critical issues in capital structure decision.

This paper responds to the general call for integration between finance and strategy research by examining how financial decisions are related to corporate strategy. In particular, the paper focuses on the link between capital structure and strategy. Corporate strategies complement traditional finance paradigms and extend our insight into a firm's decisions regarding capital structure. Equity and debt must be considered as financial instruments as well as strategic instruments of corporate governance (Williamson 1988). Debt subordinates governance activities to stricter management, while equity allows for greater flexibility and decisionmaking power. The literature on finance and strategy analyzes how the strategic actions of key players (managers, shareholders, debtholders, competitors, workers, suppliers, etc) affect firm value and the allocation of value between claimholders. Specifically, financing decisions can concern value creation process (1) influencing efficient investments decisions according to the existence of conflict of interest between managers and firm's financial stakeholders (shareholders and debtholders) and (2) affecting the relationship with non-financial stakeholders, as suppliers, competitors, customers, etc. To summarize, the potential interaction between managers, financial stakeholders, and nonfinancial stakeholders influences capital structure, corporate governance activities, and value creation processes. These in turn, may give rise to inefficient managerial decisions or they may shape the industry's competitive dynamics to achieve a competitive advantage. A good integration between strategy and finance dimensions can be tantamount to a competitive weapon.

Capital structure is the financial decisions regarding raising of funds from several sources of funds which comprise of internal (retained earnings) and external financing (debt and equity). As a commercial companies, manager will concern on minimizing cost, thus good financial decision is refer to raising funds at low cost. In ensuring the survival of firms, manager needs to have proper capital structure’s strategy and capital structure is said to be optimal when it has low acquiring funds cost and at the same time maximizes the company value. The objective of this paper is to review the determinants of capital structure among firms. Based on library research method, this paper found that firm’s characteristic play an important roles in determining firm’s capital structure.

Conference Proceedings DOKBAT, 2016

Abstract The aim of this study is to investigate the impact of capital structure on financial performance of firms. For this purpose180 manufacturing companies listed on Borsa Stock Exchange Istanbul Turkey over the period 2004 to 2013 were examined. Return on Assets (ROA) and Return on Equity (ROE) are the two performance indicators. Total Debt to Total Assets (TDTA) and Long term Debt to Total Assets (LDTA) were introduced as the capital structure of firms while size, sale growth, tangibility, intangibility and risk where included in the model as control variables. The first result obtained confirm that long term debt and total debt have a negative significant effect on the financial performance of the firm measured by ROA, While the second confirm that long term debt and total debt have no significant effect on the financial performance of the firm measured by ROE. Keywords: capital structure, firm performance, return on equity, return on assets, Borsa Stock Exchange, emerging economy

res publication, 2012

An investment decision of a manager directly affects the future profitability of the business and the financing choice is independent to investment and profitability. But financing choice decision largely affect to the way profit to be distributed among investors. Finance manager decides the strategy by which he can repay the borrowed capital on time to maintain company's goodwill and to maximize shareholder's wealth. The manager is in the dilemma debt or equity as a source of finance. Capital structure is debated subject from last century after M & M proposition on capital structure and firm value.

The capital structure is a puzzle which has been attempted to solve by researchers for the past fifty years and still there is much that needs to be explored. There have been studies which developed the theoretical models, some studies that tested these models empirically. Some studies which identified factors affecting capital structure decision and many other studies related to several aspects of capital structure have occupied the academic literature. Present study is an attempt to do an exhaustive literature review of the universe of capital structure and try figure out the contribution of prominent studies. Further, the paper attempts to identify the scope for further research in this field.

Moh'd ALHADID, 2017

ABSTRACT The research study is based on the identification of the impact that capital structure have on the financial performance of the business firm. In this regard, secondary data is collected from varied sources especially annual report and Jordon stock exchange website. The literature review is done in the report, and it is identified operating, and the capital structure heavily affects net profit. Apart from this return on equity, asset and capitals employed also affected by the capital structure of the business firm. Regression analysis and descriptive analysis tools are used to analyze the data that is related to the ten finance companies of Jordon. On analysis of data, it is identified that operating and net profit is heavily affected by the capital structure. However, in the case of return on asset, return on equity, and return on capital employed such kind of relationship is not observed. Thus, it is concluded on the basis of entire work that capital structure have the huge impact on the operating and net profit, but it does not put any large impact on the return on asset, return on equity and return on capital employed.

This research paper is the study of the corporate investment in Information Technology Industry and in the Banking Industry. The study examines the trends and determinants of capital structure in Indian Banking and IT industries from the perspective of empirical capital structure literature. There are several fundamental disparities between financial and non financial firms that contribute to large difference in their capital structure position. However, the theory of Corporate Capital Structure that evolves in recent years provides a useful framework for analyzing bank capital structure. Two independent variables, specifically, Profitability and Growth Opportunities are the chief fragments that generally direct capital structure decisions in this industry. Nevertheless, these capital structure decisions are not straightforward. Four independent variables, specifically, Tangibility of assets, Size of the company, Volatility and Non debt tax shield are the major aspects directing cap...

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Capital Structure and Value Case Study Solution

Posted by John Berg on Feb-16-2018

Introduction

Capital Structure and Value Case Study is included in the Harvard Business Review Case Study. Therefore, it is necessary to touch HBR fundamentals before starting the Capital Structure and Value case analysis. HBR will help you assess which piece of information is relevant. Harvard Business review will also help you solve your case. Thus, HBR fundamentals assist in easily comprehending the case study description and brainstorming the Capital Structure and Value case analysis. Also, a major benefit of HBR is that it widens your approach. HBR also brings new ideas into the picture which would help you in your Capital Structure and Value case analysis.

To write an effective Harvard Business Case Solution, a deep Capital Structure and Value case analysis is essential. A proper analysis requires deep investigative reading. You should have a strong grasp of the concepts discussed and be able to identify the central problem in the given HBR case study. It is very important to read the HBR case study thoroughly as at times identifying the key problem becomes challenging. Thus by underlining every single detail which you think relevant, you will be quickly able to solve the HBR case study as is addressed in Harvard Business Case Solution.

Problem Identification

The first step in solving the HBR Case Study is to identify the problem. A problem can be regarded as a difference between the actual situation and the desired situation. This means that to identify a problem, you must know where it is intended to be. To do a Capital Structure and Value case study analysis and a financial analysis, you need to have a clear understanding of where the problem currently is about the perceived problem.

For effective and efficient problem identification,

• A multi-source and multi-method approach should be adopted.
• The problem identified should be thoroughly reviewed and evaluated before continuing with the case study solution.
• The problem should be backed by sufficient evidence to make sure a wrong problem isn't being worked upon.

Problem identification, if done well, will form a strong foundation for your Capital Structure and Value Case Study. Effective problem identification is clear, objective, and specific. An ambiguous problem will result in vague solutions being discovered. It is also well-informed and timely. It should be noted that the right amount of time should be spent on this part. Spending too much time will leave lesser time for the rest of the process.

Capital Structure and Value Case Analysis

Once you have completed the first step which was problem identification, you move on to developing a case study answers. This is the second step which will include evaluation and analysis of the given company. For this step, tools like SWOT analysis, Porter's five forces analysis for Capital Structure and Value, etc. can be used. Porter’s five forces analysis for Capital Structure and Value analyses a company’s substitutes, buyer and supplier power, rivalry, etc.

To do an effective HBR case study analysis, you need to explore the following areas:

1. Company history:

The Capital Structure and Value case study consists of the history of the company given at the start. Reading it thoroughly will provide you with an understanding of the company's aims and objectives. You will keep these in mind as any Harvard Business Case Solutions you provide will need to be aligned with these.

2. Company growth trends:

This will help you obtain an understanding of the company's current stage in the business cycle and will give you an idea of what the scope of the solution should be.

3. Company culture:

Work culture in a company tells a lot about the workforce itself. You can understand this by going through the instances involving employees that the HBR case study provides. This will be helpful in understanding if the proposed case study solution will be accepted by the workforce and whether it will consist of the prevailing culture in the company.

Capital Structure and Value Financial Analysis

The third step of solving the Capital Structure and Value Case Study is Capital Structure and Value Financial Analysis. You can go about it in a similar way as is done for a finance and accounting case study. For solving any Capital Structure and Value case, Financial Analysis is of extreme importance. You should place extra focus on conducting Capital Structure and Value financial analysis as it is an integral part of the Capital Structure and Value Case Study Solution. It will help you evaluate the position of Capital Structure and Value regarding stability, profitability and liquidity accurately. On the basis of this, you will be able to recommend an appropriate plan of action. To conduct a Capital Structure and Value financial analysis in excel,

• Past year financial statements need to be extracted.
• Liquidity and profitability ratios to be calculated from the current financial statements.
• Ratios are compared with the past year Capital Structure and Value calculations
• Company’s financial position is evaluated.

Another way how you can do the Capital Structure and Value financial analysis is through financial modelling. Financial Analysis through financial modelling is done by:

• Using the current financial statement to produce forecasted financial statements.
• A set of assumptions are made to grow revenue and expenses.
• Value of the company is derived.

Financial Analysis is critical in many aspects:

• Decision Making and Strategy Devising to achieve targeted goals- to determine the future course of action.
• Getting credit from suppliers depending on the leverage position- creditors will be confident to supply on credit if less company debt.
• Influence on Investment Decisions- buying and selling of stock by investors.

Thus, it is a snapshot of the company and helps analysts assess whether the company's performance has improved or deteriorated. It also gives an insight about its expected performance in future- whether it will be going concern or not. Capital Structure and Value Financial analysis can, therefore, give you a broader image of the company.

Capital Structure and Value NPV

Capital Structure and Value's calculations of ratios only are not sufficient to gauge the company performance for investment decisions. Instead, investment appraisal methods should also be considered. Capital Structure and Value NPV calculation is a very important one as NPV helps determine whether the investment will lead to a positive value or a negative value. It is the best tool for decision making.

There are many benefits of using NPV:

• It takes into account the future value of money, thereby giving reliable results.
• It considers the cost of capital in its calculations.
• It gives the return in dollar terms simplifying decision making.

The formula that you will use to calculate Capital Structure and Value NPV will be as follows:

Present Value of Future Cash Flows minus Initial Investment

Present Value of Future cash flows will be calculated as follows:

PV of CF= CF1/(1+r)^1 + CF2/(1+r)^2 + CF3/(1+r)^3 + …CFn/(1+r)^n

where CF = cash flows r = cost of capital n = total number of years.

Cash flows can be uniform or multiple. You can discount them by Capital Structure and Value WACC as the discount rate to arrive at the present value figure. You can then use the resulting figure to make your investment decision. The decision criteria would be as follows:

• If Present Value of Cash Flows is greater than Initial Investment, you can accept the project.
• If Present Value of Cash Flows is less than Initial Investment, you can reject the project.

Thus, calculation of Capital Structure and Value NPV will give you an insight into the value generated if you invest in Capital Structure and Value. It is a very reliable tool to assess the feasibility of an investment as it helps determine whether the cash flows generated will help yield a positive return or not.

However, it would be better if you take various aspects under consideration. Thus, apart from Capital Structure and Value’s NPV, you should also consider other capital budgeting techniques like Capital Structure and Value’s IRR to evaluate and fine-tune your investment decisions.

Capital Structure and Value DCF

Once you are done with calculating the Capital Structure and Value NPV for your finance and accounting case study, you can proceed to the next step, which involves calculating the Capital Structure and Value DCF. Discounted cash flow (DCF) is a Capital Structure and Value valuation method used to estimate the value of an investment based on its future cash flows. For a better presentation of your finance case solution, it is recommended to use Capital Structure and Value excel for the DCF analysis.

To calculate the Capital Structure and Value DCF analysis, the following steps are required:

• Calculate the expected future cash inflows and outflows.
• Set-off inflows and outflows to obtain the net cash flows.
• Find the present value of expected future net cash flows using a discount rate, which is usually the weighted-average cost of capital (WACC).
• If the value calculated through Capital Structure and Value DCF is higher than the current cost of the investment, the opportunity should be considered
• If the current cost of the investment is higher than the value calculated through DCF, the opportunity should be rejected

Capital Structure and Value DCF can also be calculated using the following formula:

DCF= CF1/(1+r)^1 + CF2/(1+r)^2 + CF3/(1+r)^3 + …CFn/(1+r)^n

In the formula:

• CF= Cash flows
• R= discount rate (WACC)

Capital Structure and Value WACC

When making different Capital Structure and Value's calculations, Capital Structure and Value WACC calculation is of great significance. WACC calculation is done by the capital composition of the company. The formula will be as follows:

Weighted Average Cost of Capital = % of Debt * Cost of Debt * (1- tax rate) + % of equity * Cost of Equity

You can compute the debt and equity percentage from the balance sheet figures. For the cost of equity, you can use the CAPM model. Cost of debt is usually given. However, if it isn't mentioned, you can calculate it through market weighted average debt. Capital Structure and Value’s WACC will indicate the rate the company should earn to pay its capital suppliers. Capital Structure and Value WACC can be analysed in two ways:

• From the company's perspective, it can be analysed as the cost to be paid to the capital providers also known as Cost of Capital
• From an investor' perspective, if the expected return on the investment exceeds Capital Structure and Value WACC, the investor will go ahead with the investment as a positive value would be generated.

Capital Structure and Value IRR

After calculating the Capital Structure and Value WACC, it is necessary to calculate the Capital Structure and Value IRR as well, as WACC alone does not say much about the company’s overall situation. Capital Structure and Value IRR will add meaning to the finance solution that you are working on. The internal rate of return is a tool used in investment appraisal to calculate the profitability of prospective investments. IRR calculations are dependent on the same formula as Capital Structure and Value NPV.

There are two ways to calculate the Capital Structure and Value IRR.

• By using a Capital Structure and Value Excel Spreadsheet: There are in-built formulae for calculating IRR.

IRR= R + [NPVa / (NPVa - NPVb) x (Rb - Ra)]

In this formula:

• Ra= lower discount rate chosen
• Rb= higher discount rate chosen
• NPVa= NPV at Ra
• NPVb= NPV at Rb

Capital Structure and Value IRR impacts your finance case solution in the following ways:

• If IRR>WACC, accept the alternative
• If IRR<WACC, reject the alternative

Capital Structure and Value Excel Spreadsheet

All your Capital Structure and Value calculations should be done in a Capital Structure and Value xls Spreadsheet. A Capital Structure and Value excel spreadsheet is the best way to present your finance case solution. The Capital Structure and Value Calculations should be presented in Capital Structure and Value excel in such a way that the analysis and results can be distinguished to the viewers. The point of Capital Structure and Value excel is to present large amounts of data in clear and consumable ways. Presenting your data is also going to make sure that you don't have misinterpretations of the data.

To make your Capital Structure and Value calculations sheet more meaningful, you should:

• Think about the order of the Capital Structure and Value xls worksheets in your finance case solution
• Use more Capital Structure and Value xls worksheets and tables as will divide the data that you are looking at in sections.
• Choose clarity overlooks
• Keep your timeline consistent
• Organise the information flow
• Clarify your sources

The following tips and bits should be kept in mind while preparing your finance case solution in a Capital Structure and Value xls spreadsheet:

• Avoid using fixed numbers in formulae
• Avoid hiding data
• Useless and meaningful colours, such as highlighting negative numbers in red
• Label column and rows
• Correct your alignment
• Keep formulae readable
• Strategically freeze header column and row

Capital Structure and Value Ratio analysis

After you have your Capital Structure and Value calculations in a Capital Structure and Value xls spreadsheet, you can move on to the next step which is ratio analysis. Ratio analysis is an analysis of information in the form of figures contained in the financial statements of a company. It will help you evaluate various aspects of a company's operating and financial performance which can be done in Capital Structure and Value Excel.

To conduct a ratio analysis that covers all financial aspects, divide the analysis as follows:

• Liquidity Ratios: Liquidity ratios gauge a company's ability to pay off its short-term debt. These include the current ratio, quick ratio, and working capital ratio.
• Solvency ratios: Solvency ratios match a company's debt levels with its assets, equity, and earnings. These include the debt-equity ratio, debt-assets ratio, and interest coverage ratio.
• Profitability Ratios: These show how effectively a company can generate profits through its operations. Profit margin, return on assets, return on equity, return on capital employed, and gross margin ratio is examples of profitability ratios.
• Efficiency ratios: Efficiency ratios analyse how efficiently a company uses its assets and liabilities to boost sales and increase profits.
• Coverage Ratios: These ratios measure a company's ability to make the interest payments and other obligations associated with its debts. Examples include times interest earned ratio and debt-service coverage ratio.
• Market Prospect Ratios: These include dividend yield, P/E ratio, earnings per share, and dividend payout ratio.

Capital Structure and Value Valuation

Capital Structure and Value Valuation is a very fundamental requirement if you want to work out your Harvard Business Case Solution. Capital Structure and Value Valuation includes a critical analysis of the company's capital structure – the composition of debt and equity in it, and the fair value of its assets. Common approaches to Capital Structure and Value valuation include

• DDM is an appropriate method if dividends are being paid to shareholders and the dividends paid are in line with the earnings of the company.
• FCFF is used when the company has a combination of debt and equity financing.
• FCFE, on the other hand, shows the cash flow available to equity holders only.

These three methods explained above are very commonly used to calculate the value of the firm. Investment decisions are undertaken by the value derived.

Capital Structure and Value calculations for projected cash flows and growth rates are taken under consideration to come up with the value of firm and value of equity. These figures are used to determine the net worth of the business. Net worth is a very important concept when solving any finance and accounting case study as it gives a deep insight into the company's potential to perform in future.

Alternative Solutions

After doing your case study analysis, you move to the next step, which is identifying alternative solutions. These will be other possibilities of Harvard Business case solutions that you can choose from. For this, you must look at the Capital Structure and Value case analysis in different ways and find a new perspective that you haven't thought of before.

Once you have listed or mapped alternatives, be open to their possibilities. Work on those that:

• need additional information
• are new solutions
• can be combined or eliminated

After listing possible options, evaluate them without prejudice, and check if enough resources are available for implementation and if the company workforce would accept it.

For ease of deciding the best Capital Structure and Value case solution, you can rate them on numerous aspects, such as:

• Feasibility
• Suitability
• Flexibility

Implementation

Once you have read the Capital Structure and Value HBR case study and have started working your way towards Capital Structure and Value Case Solution, you need to be clear about different financial concepts. Your Mondavi case answers should reflect your understanding of the Capital Structure and Value Case Study.

You should be clear about the advantages, disadvantages and method of each financial analysis technique. Knowing formulas is also very essential or else you will mess up with your analysis. Therefore, you need to be mindful of the financial analysis method you are implementing to write your Capital Structure and Value case study solution. It should closely align with the business structure and the financials as mentioned in the Capital Structure and Value case memo.

You can also refer to Capital Structure and Value Harvard case to have a better understanding and a clearer picture so that you implement the best strategy. There are a number of benefits if you keep a wide range of financial analysis tools at your fingertips.

• Your Capital Structure and Value HBR Case Solution would be quite accurate
• You will have an option to choose from different methods, thus helping you choose the best strategy.

Recommendation and Action Plan

Once you have successfully worked out your financial analysis using the most appropriate method and come up with Capital Structure and Value HBR Case Solution, you need to give the final finishing by adding a recommendation and an action plan to be followed. The recommendation can be based on the current financial analysis. When making a recommendation,

• You need to make sure that it is not generic and it will help in increasing company value
• It is in line with the case study analysis you have conducted
• The Capital Structure and Value calculations you have done support what you are recommending
• It should be clear, concise and free of complexities

Also, adding an action plan for your recommendation further strengthens your Capital Structure and Value HBR case study argument. Thus, your action plan should be consistent with the recommendation you are giving to support your Capital Structure and Value financial analysis. It is essential to have all these three things correlated to have a better coherence in your argument presented in your case study analysis and solution which will be a part of Capital Structure and Value Case Answer.

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Marriott Corp.: The Cost of Capital – Case Solution

Case study analysis of Marriott Corp. through the calculation of key financial metrics, including Beta, Unlevered Beta, Weighted Average Cost of Capital (WACC), Capital Asset Pricing Model (CAPM), and other pertinent measures. The objective is to ascertain Marriott's competitive positioning within the industry by evaluating these critical financial indicators.

​Richard S. Ruback Harvard Business Review ( 298101-PDF-ENG ) February 10, 1998

Case questions answered:

• Calculation of Beta, Unlevered Beta, WACC, CAPM, and other necessary things of Marriott Corp.
• Calculation of CAPM of Marriott’s competitors.
• Calculation of WACC, CAPM, and other things for internal divisions of Mrariott Corp.

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Marriott Corp.: The Cost of Capital Case Answers

This case solution includes an Excel file with calculations.

Please scroll down to the bottom of this post to download the additional Excel spreadsheet!

Weighted Average Cost of Capital – WACC (Marriott Corp.)

Given the information extracted from the exhibits in the case, we go ahead and calculate the WACC for Marriott Corp. using the following formula.

WACC = W E * r E + W D * r D * (1 – τ)      or      WACC = E/E+D * r E + D/E+D * r D * (1 – τ)

In order to calculate the WACC, however, we first have to calculate the market value of equity (E), which we can simply achieve by multiplying the market price at year end by the number of shares outstanding.

Next up, to calculate the market value of debt (D), following the calculation below, we simply take the market value of equity (E) and multiply it by 1.5 (given that Marriott’s capital structure consists of 60% debt and 40% equity).

D/D+E = 0,6 ↔ D = 0,6 * (D+E) ↔ D = 0,6D + 0,6E ↔ 0,4D = 0,6E ↔ D = 0,6/0,4 E ↔ D = 1,5 * E

Thus, the value of the firm (V) is the market value of debt (D) + the market value of equity (E).

To compute the pretax cost of debt (r D ), we take the US Government Bond rate for ten years in order to be consistent with the given timeline (risk-free rate r f = 8.72%) and add the credit spread to it (1.3%).

To calculate the after-tax cost of equity (r E ), we use the Capital Asset Pricing Model (CAPM) formula, multiply the equity beta (1.11) by the market risk premium (7.43%) and add the risk-free rate (8.72%).

r i = r f + ß i * (E(r M ) – r f )

The corporate tax rate is computed by taking income tax paid and dividing it by income before income taxes.

Next up, we simply put these values into the WACC formula and get a weighted average cost of capital (ranging from 9.99% to 10.56%).

These values suggest that the cost of capital for Marriot Corp. is…

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MCI Communications Corp.: Capital Structure Theory A Harvard Case Solution & Analysis

Home >> Business Case Studies >> MCI Communications Corp.: Capital Structure Theory A

This case is an introductory exercise to estimate the cost of capital (cost of equity and weighted average cost of capital) to the firm handle a substantial increase in debt. Students are asked to compare the debt policy MCI connection of the other five leading telecom companies to find an optimal capital structure in MCI. "Hide by Susan Chaplinsky, Robert S. Harris Source: Darden School of Business 11 pages. Publication Date: March 31, 1997. Prod. #: UV2421-PDF-ENG

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