You have been hired as a financial consultant by two firms, Alright Industries (Firm A), and Zelda Ltd. (Firm Z). Firm A is in the fast-growing microcomputer retail sales industry, while Firm Z manufactures office equipment such as pencil sharpeners, staplers, and tape dispensers. Your job is to recommend the optimal capital structure for these 2 firms. Discuss the factors that would influence your decision, and specifically how each of the factors applies to each firm.
Additional information about the 2 firms:
a. Firm A generally leases it stores, while Firm Z purchases its plants.
b. Firm A's stock is widely held, while the family of Firm Z's founder holds 40% of its stock.
c. Firm Z has a significant amount of accelerated depreciation expense each year, while Firm A has almost none.
d. Firm A has demonstrated high growth and profitability over the last few years. On the other hand, Firm Z's growth has averaged a modest 5% per year, and its profit margins and Return On Equity (ROE) have been unspectacular.
Be thorough in your discussion.
taxes, information assymetry, non interest tax shelters, depreciation, Uniqueness of assets© BrainMass Inc. brainmass.com October 24, 2018, 5:27 pm ad1c9bdddf
Factors that influence capital structure:
1 Taxes :
Taxes are the main reason for capital structure optimization. Interest payments are deductible as an expense. Total income increases by interest payment times the tax rate. The optimal strategy is therefore to acquire a maximum of leverage. The greater the amount of debt, the greater the tax shield and the greater the value of the firm. But to derive the benefit of tax shield there should not be any uncertainty of the tax shields. The possibility of using tax shields effectively depends on net income or profitability.
Firm A therefore can make use of the tax shields effectively as it has demonstrated high growth and profitability over the last few years. In contrast Firm Z's growth has averaged a modest 5% per year, and its profit margins and Return On Equity (ROE) have been unspectacular. Therefore it would not be able to use tax shields from interest payments ...
The solution discusses the factors that influence capital structure and recommends capital structure for two firms.
Advantages and disadvantages of external financing
Capital Structure is a mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds.
Therefore, we can summarize that in the current business environment optimal capital structure has become a very interesting topic for discussion.
Having previously identified the location of its Greenfield investment, Acme, a multi-billion public MNE that is incorporated in the U.S., must next obtain external financing for its proposed overseas production facility. It has been estimated that the acquisition will cost $500M and all funds will be secured in the U.S. Your job is to explain to this committee some of the financial aspects of this acquisition.
Deliverable: At the next steering committee meeting, you will provide a detailed presentation of the characteristics of the various external financing alternatives, including the advantages and disadvantages of each. Your report should conclude with a recommendation of which alternative (or combination of alternatives) should be used to finance the overseas investment.