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After you finish your discussion with the managers and finance personnel, the head of strategic planning stops by your office to discuss the IPO. He says that recently the investment bankers started to encourage the firm to begin to use more financial leverage as a sign to Wall Street that the company would be more aggressive when it goes public. The investment bankers believe this will help with the IPO and likely generate millions of dollars in additional net proceeds. You two sit at the large conference table in your office discussing what the impact would be if the company purchased the production plant rather than leased it and if the company used debt rather than cash flow to finance the project (the company would also use debt to buy the facility).

With this in mind, discuss with the head of strategic planning how using more debt can impact a firm's capital structure. Discuss the trade-offs between incremental IPO proceeds and debt financing. How would the company's balance sheet be impacted by debt financing rather than using cash? How would the company's return on equity be impacted by utilizing more debt?

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Solution Preview

There's a lot to consider in this scenario. Because the company is going to make their IPO, investors will definitely want to see that the firm is aggressive; however there is a line for a new firm between aggressive and too risky - in which case the company would be considered too high of a risk as a public firm making their initial offering, for a safe investment. There are many advantages to buying the production plant. There are tax advantages, as ...

Solution Summary

With this in mind, discuss with the head of strategic planning how using more debt can impact a firm's capital structure. Discuss the trade-offs between incremental IPO proceeds and debt financing. How would the company's balance sheet be impacted by debt financing rather than using cash? How would the company's return on equity be impacted by utilizing more debt?

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