Capital Structure and Net Operating Income Study Guide

In order to find the WACC, we need to find the cost of the components of the capital structure and their proportion in the total capital.

The firm has decided to increase the debt finance component portion from 20% to 30% which is a good decision since the interest payments are 100% tax deductible. The appropriate capital structure would be to

• Cost of capital must reflect current capital market conditions (current required returns) • Cost of capital must also reflect the optimal relative proportions of debt and equity the firm will

At first, WACC and CAPM was attempted to be used as a source of cost of capital. However, for WACC, there is no available proportion of debt and cost of debt for MW. For CAPM, no available data seems to support the acceptable

Moreover, let’s calculate the Weighted Average Cost of Capital (WACC). And in order to calculate it we need to know the capital structure of the company. Knowing the capital structure of the

Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that

Notes and Hints: The WACC is equal to the weighted average of the component capital costs, e.g., the weight in debt times the after-tax cost of debt financing plus the weight in equity times the after-tax cost of equity financing corresponding to the leverage: WACC = (D/V)*Rd*(1− tax rate) + Re*(E/V), where “tax rate” = marginal corporate tax rate (assume 34%), Rd = the before-tax cost of debt (info about the premium above long-term government rates is provided in tables), Re is the cost of equity, D and E are the market values of debt and equity. V = (E + D). Remember that the higher leverage means the higher equity risk (and cost of equity Re) and that you will have to “un-lever” and “re-lever” your firm’s cost of equity and any other firm (pure-plays) when evaluating a project in a specific division. Note that your firm (and comparable “pure-play” firms) may have different leverage (capital structures) than the target leverage of your firm and estimated equity ‘betas’ will reflect the past leverage!! Also, your firm may have several divisions and the individual divisional projects may have different risks and thus different costs of capital!! Pay special attention to the information and questions under the “The 777” case segment (pages 6-9). State your parameters & assumptions very clearly. Someone looking at your analysis should be

c) Optimization of the capital structure is also consistent with the growth of the company. The optimal capital structure

We would recommend the capital structure with 30% debt. This is because with 30% debt, they would be able to repurchase 19.8 million shares outstanding as well as save 37.8 million in taxes. EBIT is high in this company, and because of this, financial leverage will raise EPS and ROE. However, variability also increases as financial leverage increases, so the company would not want to take on too much debt and become very risky.

With all the above aspects considered, Adecco arrived at a debt portion of WACC equal to .96% and an equity portion of 9.31% resulting in an overall WACC of 10.27%. This was calculated utilizing a beta of equity considering a beta of debt and assets of 0.2 and 0.48 respectively. Utilizing the free cash

Weight of Equity = 71%; Equity Cost of Capital = 12%; Weight of Debt = 29%; Debt Cost of Capital = 4.55%

A firm can choose a mix of three modes of financing i.e. issuing shares, borrowing from the market and use of retained earnings. The ratio of this mix of funds purely depends on the firm and known as optimal capital structure of the firm. This leads to the different capital structure theories. These theories explain their

Capital structure is defined as the mix of the long-term sources of funds that a firm use. It is composed of equity, debt securities and affect long-term financing of the entity. It is made up by shareholder’s funds, long-term debt and preference share capital. The capital structure mostly focus on the proportions of debt and equity displayed in the company financial statements, especially in the balance sheet (Myers, 2001). The value of a firm can be calculated by the sum of the value of its firm’s debt and equity.

The purpose of the report is to understand the capital structure of the chosen company on the basis of the financial statements of the company which includes the income statement, balance sheet and the cash flow statement of the company and do the capital analysis of the company as well to find out the advantages and disadvantages in working capital of the company and suggest company logical and useful ways for growing their economy.

Capital structure is the proportion of debt and equity in which a corporate finances its business. The capital structure of a company/firm plays a very important role in determining the value of a firm. There are various theories which propagate the ‘ideal’ capital mix / capital structure for a firm.