Strategic Corporate Finance - Essay Example

? Strategic Corporate Finance and Strategic Corporate Finance Capital structure of a company refers to the combination of debt and equity employed by that company to finance the operations of that company. It refers to the different types of sources of finances used and to what ratio they finance the business (Ehrhardt, 2013). Companies are primarily financed by long term debt, their share issued and the equity contributed by the owners in different mixes. A capital structure decision therefore involves allocating a percentage of financing to any of these various source of finances. A financial structure of a company on the other hand includes the short term debts, business creditors and other short term liabilities (Ho and Lee, 2003). Most businesses finance their business through debt or equity or a combination of both. Through debts the companies secure long term bank loans or take bonds which are redeemable after a long period of time. Through equity the companies issue common shares, preferred shares and sometimes the retained earnings injected at the end of the trading period where a profit has been realized. This literature will examine the financial books and ratios of 3 companies and determine their financial structure and the risks they run in choosing that particular mix (Ehrhardt, 2013). The choice of whether to use exclusive debt or equity financing or what mixture depends on the financial position of the business, the credit standing, the tax situation of the country and the nature of the business. This mix will determine what the cost of capital is (Finnerty, 2013). Equity financing has its own advantages in that there is no burden of debt hanging over the owner’s heads, they therefore do not run the risk of going bankrupt unlike when financed by a debt. The owners too consent to the risk of losing all their investment in case the business fails. The disadvantages of equity financing is that the many the investors the more the control of the business is diluted and so are the profit shares. Debt financing on the other hand is advantageous to the management of the business in that the lenders do not take any control of the business or direct how the money lent will be spent. The lenders also do not share the profit of the company, all they are entitled to is the loan repayment and the interest on loan. But one of the major advantages of debt financing is that it reduces the tax liability of the business because the interest paid on loan is tax deductible. This protects a part of income from taxation and at the same time lowering your business’ tax liability. The disadvantages of debt financing involve ruined credit rating and risking bankruptcy (Besley and Brigham, 2008). An optimal capital structure is one that attains a good balance between the returns of the capital structure and the risks that the structure exposes the company to. The optimal capital structure will minimize the risks involved yet maximize the returns and it also increases the valuation of the stock in the stock market at the same time minimizing the cost of capital (Ho and Lee, 2003). eBay This is a multinational company based in America with outlets in more than 30 countries worldwide. It was started in 1995 and deals with providing consumer-to-consumer internet services. Its nature of business involves providing an over the internet market where customers can auction their goods, this was the initial venture. However, with time the company has diversified its services providing online advertisement services through eBay classifieds, online payment through PayPal and online event ticket trading through StubHub (Gitlin, 2007). Between 2005 and 2009 it had acquired Skype but then sold a majority stake so as to concentrate on the other internet services it was renowned for. Examining the financial statements of the company for the period ended 31st December 2012 the following information was obtained. The company has a total assets value of $37.074 billion comprising of $21.398 billion current assets and $15.676 billion long term assets. The total liability which is the money borrowed by the company for the purpose of operations totaled $16.209 billion. During the mentioned period the company made sales worth $14.072 billion and was left with a net profit of $2.609 billion after deducting the operational expenses (eBay, 2013). Examining the company’s ratios provided some useful insight towards understanding the capital structure and the profitability of the company. For instance, with the total long term liability of $5.285 and equity financing of $20.865 the company had a 25.33% debt equity ratio. This shows that for each dollar of equity nearly a quarter of it has been financed by a long term debt. This is a healthy level to maintain. Comparing net profit to sales provided a profit margin ratio of 18.54%. The return on equity ratio was 12.50% whereas that of return on investment was 7.03%. The company also had a beta ratio of 0.8 meaning that its assets were generally moving in the same direction as that of other firms in the industry (eBay, 2013). It has relative financial relativity which means that it is within the acceptable risk since the stock is quite stable (Lee, lee and Lee, 2010). The Clorox Company Clorox Company is a food, chemicals and consumer products manufacturing company. It is best known for its bleaching product but is also known for manufacturing water filtration systems, drain cleaners, hard surface cleaners and cosmetics and beauty products (The Clorox Company, 2013). In the trading period ending 30th June 2013 it made a profit totaling $0.572 billion. Examining its financial statements revealed that the company has total assets valued at $4.311 billion comprising of $1.42 billion current assets and $2.891 billion long term assets. It also had current liabilities of $1.134 billion and long term liabilities of $3.031 billion. It made sales totaling $5.623 billion being its total revenue. As for the ratio, the company had a debt equity ratio of 2076% meaning that it was largely financed by debt as opposed to equity. The long term liabilities of Clorox Company were $3.031 billion as compared to equity contribution of only $0.146 billion. The profit margin was 10.17%, return on equity stood at 8.35% while its return on investment ratio stood at 13.27% as shown in the calculations in the appendix. The beta ratio was 0.48 meaning that the company’s stocks were at a low risk of fluctuation and so the loaned money was relatively safe (Vinter and Price, 2011). Alaska Air Group This company was formed in 1985 and is based in Washington. It operates two airlines in the US; Alaska Airlines and Horizon Air (Alaska Air Group, 2013). Due to the competitive nature of airline business the company had a beta ratio of 1.06, relatively high as compared to the normal range. Alaska Air Group is operating in a highly volatile market, its stocks are moving in the same direction as that of the market but at a faster rate placing the company in a high market risk category. In the period ended 31st December 2012 the company managed a profit of $0.316 billion and a revenue total of $4.657 billion. It had a profit margin of 6.79% indicating the firm’s ability to control its costs of sales, operating expenses and financing costs. The debt equity ratio stood at 181.78% indicating that the company was majorly debt financed as opposed to equity financed. It had a total long term liability of $2.583 billion while its equity contribution was only $1.421 billion. The profitability was however rewarding to the equity advanced with a return on equity ratio of 22.34% and a return on investment ratio of 5.74% as shown in the operations attached in the appendix (Alaska Air Group, 2013). Conclusion It is clear that each company has its own capital structure with a unique capital mix. This mix is determined by the nature of the business being conducted which in turn influences the movement of stocks (Megginson and Smart, 2008). The decision of capital structure rests on the management. Of the three companies, Alaska Air Group is the one in the riskiest field yet it has a high debt financing. This places it at a risk of being declared bankrupt if it fails to fulfill its debt obligation but also it recorded a high profit margin because of the tax exemption of its huge debt financed capital (Ehrhardt, 2013). Clorox is in a stable market where volatility is at a manageable level but still chose to finance its operations through debt while eBay is in a relatively volatile market yet raised its capital mainly through equity financing at 74.66% of the capital. The recommended capital structure for Clorox can be a mix with debt forming the majority of its financing because its beta rate is at 0.48 which is a steady market. The recommended capital structure for eBay is a half debt and equity financing so as not to subject itself to the risk of bankruptcy in its not-so-volatile market. Alaska Airline Group, being in a high-risk volatile market, it should seek to finance its capital through equity, this way if the venture fails then they are not obliged to pay the shareholders who had consented to explore a viable business opportunity by investing their money in stocks (Seidman, 2005). References Alaska Airlines. (2013). Corporate Overview. Alaska airlines. Retrieved from http://phx.corporate-ir.net/phoenix.zhtml?c=109361&p=irol-IRHome Besley, S. & Brigham, E. (2008). Essentials of Managerial Finance. London: Cengage Learning. eBay Inc. (2013). Commerce Revolution. Ebay.com. Retrieved from nvestor.ebay.com/#&panel1-2 Ehrhardt, M. (2013). Corporate Finance: A Focused Approach. London: Cengage Learning. Finnerty, J. (2013). Project Financing: Asset-Based Financial Engineering. Tampa: John Wiley and Sons. Gitlin, M. (2007). EBay: The Company and its founder. New York: ABDO. Ho, T. & Lee, S. (2003). The Oxford Guide to Financial Modeling: Applications for Capital Markets, Corporate Finance, Risk Management and Financial Institutions. Oxford: Oxford University Press. Lee, C., Lee, A., & Lee, J. (2010). Handbook of Quantitative Finance and Risk Management. New York: Springer. Megginson, W. and Smart, S. (2008). Introduction to Corporate Finance. London Cengage Learning. Seidman, K. (2005). Economic Development Finance. New York: SAGE. The Clorox Company. (2013). Extraordinary Products. Thecloroxcompany.com. Retrieved from http://www.thecloroxcompany.com/products/ Vinter, G. and Price, G. (2011). Project Finance. Glasgow: Sweet and Maxwell. Appendix eBay Financial Details for the period ended 31st December 2012(All amounts in Billions US Dollars) i) Assets Total Assets= 37.074 Total Current Assets=21.398 Total Long Term Assets= 15.676 ii) Liabilities Total Current Liabilities= 10.924 Total Long Term Liabilities= 5.285 iii) Revenue= 14.072 iv) Beta Ratio= 0.8 v) Debt Equity Ratio== 5.285/20.865*100=25.33% vi) Profit Margin= NP/Sales*100= 2.609/14.072*100= 18.54% vii) Return on Equity= NP/Equity*100= 2.609/20.865*100= 12.50% viii) Return on Investment= NP/Total Assets*100= 2.609/37.074*100= 7.03% Clorox Company Financial Details for the year ended 30th June 2013 (All amounts in Billions US Dollars) i) Assets Total Assets= 4.311 Total Current Assets=1.42 Total Long Term Assets= 2.891 ii) Liabilities Total Current Liabilities= 1.134 Total Long Term Liabilities= 3.031 iii) Revenue= 5.623 iv) Beta Ratio= 0.48 v) Debt Equity Ratio== 3.031/0.146*100= 2076% vi) Profit Margin= NP/Sales*100= 0.572/5.623*100= 10.17% vii) Return on Equity= NP/Equity*100= 0.572/0.146*100= 8.35% viii) Return on Investment= NP/Total Assets*100= 0.572/4.311*100= 13.27% Alaska Air Group Financial Details for the year ended 31st December 2012(All amounts in Billions US Dollars) i) Assets Total Assets= 5.505 Total Current Assets=1.737 Total Long Term Assets= 3.768 ii) Liabilities Total Current Liabilities= 1.501 Total Long Term Liabilities= 2.583 iii) Revenue= 4.657 iv) Beta Ratio= 1.06 v) Debt Equity Ratio== 2.583/1.421*100= 181.78% vi) Profit Margin= NP/Sales*100= 0.316/4.657*100= 6.79% vii) Return on Equity= NP/Equity*100= 0.316/1.421*100= 22.24% viii) Return on Investment= NP/Total Assets*100= 0.316/5.505*100= 5.74% Read More