Saturday, October 12, 2019
Introduction to Debt Policy Essay -- essays research papers
When a firm grows, it needs capital, and that capital can come from debt or equity. Debt has two important advantages. First, interest paid on Debt is tax deductible to the corporation. This effectively reduces the debt’s effective cost. Second, debt holders get a fixed return so stockholders do not have to share their profits if the business is extremely successful. Debt has disadvantages as well, the higher the debt ratio, the riskier the company, hence higher the cost of debt as well as equity. If the company suffers financial hardships and the operating income is not sufficient to cover interest charges, its stockholders will have to make up for the shortfall and if they cannot, bankruptcy will result. Debt can be an obstacle that blocks a company from seeing better times even if they are a couple of quarters away. Capital structure policy is a trade-off between risk and return:  ·Ã‚     Using debt raises the risk borne by stock holders  ·Ã‚     Using more debt generally leads to a higher expected rate on equity. There are four primary factors influence capital structure decisions:  ·Ã‚     Business risk, or the riskiness inherent in the firm’s operations, if it uses no debt. The greater the firm’s business risk, the lower its optimal debt ratio.  ·Ã‚     The firm’s tax position. A major reason for using debt is that interest is tax deductible, which lowers the effective cost of debt. However if most of a firm’s income is already sheltered from taxes by depreciation tax shields, by interest on currently outstanding debt, or by tax loss carry forwards, its tax rate will already be low, so additional debt will not be as advantageous as it would be to a firm with a higher effective tax rate.  ·Ã‚     Financial flexibility or the ability to raise capital on reasonable terms under adverse conditions. Corporate treasurers know that a steady supply of capital is necessary for stable operations, which is vital for long-run success. They also know that when money is tight in the economy, or when a firm is experiencing operating difficulties, suppliers of capital prefer to provide funds to companies with strong balance sheets. Therefore, both the potential future need for funds and the consequences of a funds shortage influence the target capital struct... ...p;   1,701,744     668,391 Total Value     1,701,744     2,234,077 Total per share = (Total Value)/(No. of Shares)      60.50     79.43      Before re-capitalization, the weight of debt of the Kopper’s firm is around 9.1% (172,409 / 1,889,153) and the share price is $60.50. Issuing a debt of $1,738,095,000 has changed the capital structure of the firm and the new weight of Debt is 71.8% (1,738,095 / 2,421,486). Though, the share price has decreased to $23.76 after re-capitalization, shareholders have a cash flow of $79.43 due to the dividend of $55.67 (79.43 - 23.76) paid out. Share Price before Re-capitalization     $60.50 New Share Price after Re-capitalization (SP)     $23.76 Number of Shares (N)     28,128 Value of Dividend Paid Out (D)     $1,565,686 Dividend Distributed per share (Div/share = D/N)     $55.67 Total Value to Shareholder (SP + Div/Share)     $79.43 Introduction to Debt Policy Essay -- essays research papers When a firm grows, it needs capital, and that capital can come from debt or equity. Debt has two important advantages. First, interest paid on Debt is tax deductible to the corporation. This effectively reduces the debt’s effective cost. Second, debt holders get a fixed return so stockholders do not have to share their profits if the business is extremely successful. Debt has disadvantages as well, the higher the debt ratio, the riskier the company, hence higher the cost of debt as well as equity. If the company suffers financial hardships and the operating income is not sufficient to cover interest charges, its stockholders will have to make up for the shortfall and if they cannot, bankruptcy will result. Debt can be an obstacle that blocks a company from seeing better times even if they are a couple of quarters away. Capital structure policy is a trade-off between risk and return:  ·Ã‚     Using debt raises the risk borne by stock holders  ·Ã‚     Using more debt generally leads to a higher expected rate on equity. There are four primary factors influence capital structure decisions:  ·Ã‚     Business risk, or the riskiness inherent in the firm’s operations, if it uses no debt. The greater the firm’s business risk, the lower its optimal debt ratio.  ·Ã‚     The firm’s tax position. A major reason for using debt is that interest is tax deductible, which lowers the effective cost of debt. However if most of a firm’s income is already sheltered from taxes by depreciation tax shields, by interest on currently outstanding debt, or by tax loss carry forwards, its tax rate will already be low, so additional debt will not be as advantageous as it would be to a firm with a higher effective tax rate.  ·Ã‚     Financial flexibility or the ability to raise capital on reasonable terms under adverse conditions. Corporate treasurers know that a steady supply of capital is necessary for stable operations, which is vital for long-run success. They also know that when money is tight in the economy, or when a firm is experiencing operating difficulties, suppliers of capital prefer to provide funds to companies with strong balance sheets. Therefore, both the potential future need for funds and the consequences of a funds shortage influence the target capital struct... ...p;   1,701,744     668,391 Total Value     1,701,744     2,234,077 Total per share = (Total Value)/(No. of Shares)      60.50     79.43      Before re-capitalization, the weight of debt of the Kopper’s firm is around 9.1% (172,409 / 1,889,153) and the share price is $60.50. Issuing a debt of $1,738,095,000 has changed the capital structure of the firm and the new weight of Debt is 71.8% (1,738,095 / 2,421,486). Though, the share price has decreased to $23.76 after re-capitalization, shareholders have a cash flow of $79.43 due to the dividend of $55.67 (79.43 - 23.76) paid out. Share Price before Re-capitalization     $60.50 New Share Price after Re-capitalization (SP)     $23.76 Number of Shares (N)     28,128 Value of Dividend Paid Out (D)     $1,565,686 Dividend Distributed per share (Div/share = D/N)     $55.67 Total Value to Shareholder (SP + Div/Share)     $79.43
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