Capital Structure Decision- Mattel, Clorox, MGM Resorts
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Capital Structure Decision and the Cost of Capital
In simple words, the capital is the combination of debt and equity used to finance a company. The background readings of this Module provide plenty of information regarding both the issue of the capital structure decision and the concept of the weighted average cost of capital.
Consider three companies: Mattel, Clorox, and MGM Resorts International. Reflect on the nature of the business of these three companies. You are recommended to also get to the web site of one company in each of these categories. You might also check what the beta of each of these companies is.
Based on the readings of the Module, and upon reviewing the nature of the operations of the companies including the nature of their customers and products, what would you recommend should the capital structure (total liabilities or debt and equity proportions) be for each of the three companies?
Note that you are not asked to provide specific numbers, just 'low debt ratio', 'medium debt ratio' or 'high debt ratio'. (Do not quote the actual company's capital structure or their debt-to-equity ratios as per their balance sheet.)
Write a report explaining your recommendations for each of these three companies. Consider the nature of their business, the riskiness of the company, and the advantages and disadvantages of debt over equity financing in your answers.
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Solution Summary
6 pages, 1600 words, APA format with references.
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INTRODUCTION
The debt ratio of any enterprise is the core concern if its strategic financing. Various factors contribute to whether a company should take-on a high, medium, or low debt load. These include the tax rate, earnings variance, and asset beta (TUI University, 2010). Three examples of debt ratio considerations are Mattel, Inc, MGM Resorts, and the Clorox Company. MGM Resorts current situation supports as low a debt-ratio as possible, Mattel, Inc should leverage a medium debt ratio, and Clorox is currently best suited for a high-debt ratio.
MGM RESORTS - LOW DEBT RATIO
MGM Resorts (MGM) MGM Resorts International (formerly MGM MIRAGE) is one of the world's largest gaming firms. The company's more than 15 partially or wholly owned properties include some of the biggest names on the Las Vegas Strip, including MGM Grand, The Mirage, and the Monte Carlo, as well as Luxor, Bellagio, and Mandalay Bay. (Hoovers, nd). Just a few short years ago, MGM was expanding aggressively, building audacious new resort space in the form of the City Center in Las Vegas, (MGM, 2011). Now, with the economy in decline - or at least suffering - the idea of throwing money at a casino get-away seems like an anachronism.
MGM faces competition from a wide array of sources some within the casino resort industry, but most notably from outside the industry. Customers choosing austerity inspired vacations outside the casino industry have sapped profitability from MGM, (MGM, 2011). MGM cash flow is uncertain in the near term, ensuring very high variance in their earnings forecasts over the course of 2012. This is also captured in MGMÃ?¢??s beta at 3.68, (Reuters, 2011a). The current uncertainty of MGMÃ?¢??s business model supports a low-debt load, relying on marketing innovation to raise capital through equity, and alleviating the near-term threat of bankruptcy due to default of debt agreements.
With a Beta of 3.68, Borders will pay a premium for equity, (Reuters, 2011a). Using the CAPM model, Borders will be expected to return 13.04% over the mid-term:
RE= RF + Beta (RM - RF)
RE= 2.0% +3.68(5%-2.0%)
RE= 13.04%
Risk free rate assumes a 10-year US Treasury bond yield (Bloomberg, 2011), and an average market return of 5% (Foroohar, 2011). While 13% is a very high cost of equity, it is certainly within reach assuming creative and aggressive adjustment of MGMÃ?¢??s marketing model, and most importantly, at least a modest recovery of the aggregate economy.
MATTEL - MEDIUM DEBT RATIO
Mattel, as the top toy maker in the world, produces Barbie and Polly Pocket dolls, Fisher-Price toys, Hot Wheels and Matchbox cars, American Girl dolls and books, and various Barney, Ferrari, and other licensed items. Mattel also sells ...
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