The Capital Structure Decision and the Cost of Capital - Research Paper Example

?Running Head: DEBT-EQUITY RATIO Debt/Equity ratio is a kind of measure that determines a given business’s financial leverage. It is gotten by dividing the aggregate liabilities of a company by its shareholders’ equity. This is translated to mean the proportion that a business has as equity capital in comparison to the proportion that it holds as debt for the purposes of financing the assets of the company. It determines long-term borrowings’ paying ability of a given company. Thus a lesser D/E ratio would be recommended for a typical company. Therefore, D/E ratio = aggregate liabilities/ shareholders’ equity A very high D/E ratio would translate to the fact that the company has been applying debt in its growth to a high extent. The resultant impact is a scenario of very volatile earnings by the company due to the marginal interest expense. If a company applied a lot of debt financing to finance additional business operations, this would result to more generation of revenues and if the revenues outdo the costs, then the shareholders would be left better of since they would earn more dividends. But it is essential to note that this is if, and only if, the earnings surpass the cost of debt. D/E ratios may also vary depending upon the industry the company is operating. For instance, a company that is highly capital intensive would have a higher D/E ratio than those who operate computer software operations. (Gibson, 2008 p260) MATTEL Mattel is a premier company for toys. It designs, manufactures as well as markets toys. The Company’s believes that PLAY is vital for the development of Children besides other benefits. These include the development of imagination and creativity, good healthy interaction and the construction of strong learning foundation among others. Most of Mattel’s business is done online. For instance, they encourage customers to explore their activities online where there are also puzzles as well as printable games. As a matter of fact they urge clients to sign up and enjoy various products that they have in offer. They say in their website ‘stop by our online Mattel shop..’ for the ideas about toy deals and gifts. Theirs is a virtual toy store that can deliver upon request and they also encourage people who are ready to do business with them online to open up affiliate programs and earn 4% commissions. They say their business is global and thus, internationalized and have subsidiaries besides the parent company which is registered in the US. (mattel.com, 2011) Mattel’s gross sales are formed up as follows: 30% in Latin America, 52% in Europe, 11% in Asia Pacific and 7% in others areas. They manufacture toy products themselves as well as outsourcing from other companies. Their main manufacturing facilities are set up in Indonesia, China, Malaysia, Thailand and Mexico. Their business is also seasonal where they experience peaks during the traditionally set holiday seasons. In fact the biggest sale revenues are experienced in the 3rd and 4th quarters of their fiscal year. The risks facing Mattel are only based on non-satisfaction of clients since its business depends almost entirely on Toy business. Shifts in demand would, therefore, impact adversely on their business. Seasonality as mentioned earlier is also another risk as well as inaccurate anticipation of the trends and culture. Though no market beta is given on this website, it is stated in their 2010 financial reports that the business is highly dependent on market behavior, where it faces to a large extent both foreign and local market rates of interest variances that form up market financial risk. (files.shareholder.com, 2011) Mattel Company had a market beta of 1.0 as reported by smartmoney.com website as of 2011. (smartmoney.com, 2011) Due to the high levels of financial risks that Mattel as a company faces and its doing business world wide, usage of debt as a source of capital would have a very huge impact on the capitalization of the company. Therefore, the recommendation is for the company to use a bigger share of stock capital as opposed to debt capital. Thus, debt-capital ratio should be low. (files.shareholder.com, 2011) CLOROX The Clorox Company deals in manufacturing as well as marketing institutional and consumer kind of commodities. It had about 8,300 employees and revenues of about USD5.2 billion in year 2010. It does business both in the US and internationally. It has four main segments; lifestyle, cleaning, international and household. It sells its commodities by way of grocery stores, mass merchandisers, retail outlets, and grocery stores. (google.com, 2011) Clorox Company is a company whose main business is cleaning and in this line it has a full range of products for cleaning. Their main concentration is in disinfectant products that aid in fighting and killing germs. However, disinfectants business is not the only area that Clorox concentrates. The other areas that the company focuses are areas like laundry business. Its goal is to become a global leader in the front of curbing infections, which are among the biggest problems to people around the world in entirety. Clorox has a variety of cleansing products that are sold globally besides the education of people to understand the importance of these products in fighting diseases and infections. (thecloroxcompany.com, 2011) The Company faces a range of risks emanating from internally and externally alike. More so, this is because it does business both in the US and globally. Its market beta stands at 0.41 as per the Google report. (google.com, 2011) This means that the existing market factor risk is higher than the Company’s. Judging from the market risk that is reflected from the analysis of its accounts and the nature of its business it, thus, follows that the company should use high debt ratio. MGM Resorts International MGM Resorts International Company forms one of the largest world wide hospitality companies. It operates a portfolio comprising destination brands of resort. This is with the inclusion of MGM brand, Bellagio, The Mirage and Mandalay Bay. It has large holdings in hospitality, gaming as well as entertainment. It also owns 15 properties, which it operates as well, in Mississippi, Nevada, and Michigan. Through the company’s subsidiary of hospitality management MGM holds an increasing magnitude of management and development agreements for projects of casino as well as non-casino resort globally. In fully owned resort businesses by MGM international, the MGM’s primary casino as well as operations of hotel businesses are owned and at the same time managed by MGM. Other amenities of resorts by MGM are operated and owned by MGM, but the management is left to be a responsibility of third parties. But the third parties operate these businesses and submit a fee to MGM or they pay lease costs for the business establishments. MGM Company also operates numerous managed types of outlets, where third-party management is what is utilized to ensure a knack of expertise is applied. Such expertise is called for in areas of business like night clubs, restaurants and branding business opportunities. This internationally operating company has many holdings in form of hospitality, entertainment and gaming. The company’s beta as per the 2010 report of the market risk level was 3.85. (Montgomery.alabama.galaxystocks.com, 2011) This means that the business was 3.85 times riskier than the market it operates in. This therefore translates to a very high level of risk for which the company has to look into ways to leverage. At this level of risk, therefore, the recommendation to the company is to apply a low debt-equity ratio in its operations. This is due to the fact that if it utilized a lot of debt, which carries with it a high finance risk, operations of the company would be adversely affected. Reference: thecloroxcompany.com. (2011). 2010 Annual Report to Shareholders and Employees. Retrieved 1 June 2011 http://www.thecloroxcompany.com/investors/financialinfo/annreports/clxar10/ar10_com plete.pdf files.shareholder.com. (2011). 2010 annual report. Retrieved 1 June 2011 http://files.shareholder.com/downloads/MAT/1270910836x0x455252/1587E36E-D23A- 4783-8AC3-A3ADE3FE9A6F/2010_Mattel_Annual_Report_Bookmarked_.pdf Gibson, Charles H. (2008). Financial Reporting and Analysis (Book Only). Edition11. Cengage Learning. p260. google.co.ke. (2011). The Clorox Company. Retrieved 1 June 2011 http://www.google.com/finance?q=NYSE:CLX mattel.com . (2011). Mattel. Retrieved 1 June 2011 http://www.mattel.com/ montgomery.alabama.galaxystocks.com . (2011). MGM Resorts International Management to Present at JP Morgan Forum - NYSE:MGM. Retrieved 1 June 2011 http://montgomery.alabama.galaxystocks.com/7295/business-news/mgm-resorts- international-management-to-present-at-jp-morgan-forum-nysemgm/ smartmoney.com. (2011). Mat (Mattel inc). Retrieved 1 June 2011 http://www.smartmoney.com/quote/mat/?story=glossary Read More