Using your knowledge about the determinants of an optimal capital structure, discuss the choice of capital structure of the three companies: Anheuser Busch, Cisco and Disney (attached are their Balance Sheet Ratios).
To keep your work focused on the problem, please consider the following topics:
Capital structure: relative amount of permanent short-term debt, long term debt, preffered stock and common stock used to finance a firm.
Business risk: variability of a firms operating income and its use of operating leverage.
Financial risk: additional variability of earnings per share and the increased probability of insolvency that arises when a firm uses fixed-cost sources of funds, such as debt and preferred stock in its capital structure.
The use of financial leverage: increase in perceived risk to the suppliers of a firms capital. To off-set this increase risk, higher returns are required.
Operating leverage: when a firm uses assets having fixed operating costs. The degree of operating leverage (DOL) measures the % change in a firms EBIT resulting from 1 % change in sales.
Financial leverage: occurs when a firm makes use of funds (from debt and preferred stock) having fixed capital costs.
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The company's capital structure seems to have been relatively stable apart for a period of about two years in 2008 and 2009. These two years come as a no brainer due to the recession period then. There seems to have been quite some sale on fixed assets to take care of declining sales. As a result, from the leverage rations, the company employed quite a bit of long-term debt to pull it out of reduced cash flows and equivalents. One of the other long-term capital raising was the use of common stock as this is constantly seen to increase. The firm shied away from using preferred stock and minimized on the use of short -term debt.
Given its working capital as a percentage of its total capital, the firm seems to have really been maximizing and utilizing its operating income. This is no surprise as it must have streamlined its operations so as to increase profitability and reduce long-term liabilities.
Given that the firm raised a considerable amount of debt over the previous two years, it reduced its financial risk to take care of operations. Its accounts receivables also reduced during this period, an indication that debtors were paying up more quickly and enabling the firm to have access to cash.
The use of financial leverage:
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Optimal capital structures are examined.