Capital Structure and Net Operating Income Study Guide

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

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.

10. What is the correct capital structure and weighted average cost of capital for discounting the investment’s free cash flow. Assume a 35% tax rate. A correct response requires that you define capital structure and Weighted Average Cost of Capital (WACC) with a formula. When defining a term with a formula be sure that all the variables are also defined.

• 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

Nevertheless, the use of the Optimal Capital Structure (OCS) is the right techniques to be used in order to acquire the right combination of debt and equity that can maximize the

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.

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

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

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

Once the prevailing WACC rate was found, the target WACC was calculated to be 9.00%. Again the CAPM model was used but a new the required rate of return on equity needed to be calculated. Since there is a change in the capital structure an unlevered beta needed to be determined. The Hamada equation was used to unlever the beta, which had a debt to equity ratio of .70, then to re-lever it again with a debt to equity ratio of 1.5; this changed the beta from

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

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

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.