Competitive Review of Debt and Equity Mix
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• Investment Analysis and Recommendation Paper – continued
This week you will prepare the final section of your Investment Analysis and Recommendation Paper, consisting of the capital structure choices, as well as an executive summary of your research.
You will examine the mix of debt and equity that your firm uses. After finding this information:
• Compare this to an industry average or a main competitor. What are the differences?
• Based on what you know about your selected company, do these differences seem appropriate?
• Relate your company’s capital structure choices to the appropriate capital structure theory (ies).
Also, as a component of your executive summary, obtain the current stock price for your company and use it as an additional calculation. Based upon all of your research, would you recommend investing in this company? Justify your answer.
SAMPLE ANSWER
Debt and Equity
Competitive Review of Debt and Equity Mix
The cost of equity is more expensive than the cost of debt. But the optimal structure of the company shows that equity capital is preferable to the company than the debt. The ratio of debt to equity in 2014 – 2012 was 4:6
| APC | 2014 | 2013 | 2012 |
| Equity | 19,725 | 21,857 | 20,629 |
| Debt | 15092 | 13065 | 13269 |
| debt/Equity | 0.4 | 0.4 | 0.4 |
Table 5
Market Value of Equity
| APC | 2014 |
| Shares outstanding | 52 million |
| Price as of 13.36 per share
Market value of equity |
721 million |
| CAPM | 27.35 |
(Yahoo Business Finance, n,d).
Debt
The cost of debt for APC for 2014 was 5.1 while for the years 2013 and 2014 it was 5.2 and 5.5 respectively.
| APC (millions) | 2014 | 2013 | 2012 |
| Long term Loan | 15092 | 13056 | 13269 |
| Interest paid | 772 | 686 | 742 |
| Cost of debt | 5.115 | 5.254 | 5.592 |
Table 6
Cost of Debt
| APC | 2014 |
| Long term debt
Current Portion of Debt Total Debt |
15092 m
– 15092 |
| Cost of Debt % before taxes | 4% |
| Tax Rate | 35.8% |
| (5) | |
Weighted Cost of Capital
Table 7
Weighted Cost of Capital Raw Data
| Company name | Value $ | % | ||||
| Equity (Rs) | 19,725 | 0.566 | ||||
| Debt (Rb) | 15092 | 0.433 | ||||
| Total Value | 34,817 | 1 | ||||
(6)
= 15,092/34817 x 0.57 + 15092/34817 x 0.47 (1-0.358)
= 4.51%
Capital Budgeting Assumptions
The assumptions made are that the business has been taken as a going concern and it has been assumed that the directors of the business have no intention of closing the company in the near future (Brooks & Mukherjee, 2013).
Capital Structure Theories
The capital structure of APC reveals that the debt to equity ratio 4:6. It means that the ratio is optimal for the operations of the company. The capital structure theories can be traced to Modigliani and miller. The theories assume that the cost of capital is reflected by the country’s risk free rate which is also assumed to be constant while the growth rate is assumed to be zero as all the earnings supposedly paid out as dividends. The investors are assumed to have homogenous expectations while the market is perfect. The risk free rates have been taken as 4% while the calculated interest rates for APC are approximately 5% (Ross, Westerfield & Jaffe, 2013).
The theories state that the cost of equity is more expensive than the cost of equity especially where the concerned company has a lot of assets. The trade off theory applies partially to the capital structure of the firm as its struggling to maintain a balance between the debt and equity capital.
Summary
The shares of the company are fair and the prices of the shares are also high. In the last five years the shares of APC have fluctuated constantly between 80 and 83 but the lowest share price was 47.41 recorded in August 2010 while the highest was 112.69 recorded in August 2014. At 84.79 dollars the shares are very expensive but the company is facing a positive future given that the profits are reducing (Berk, DeMarzo, Harford, Ford, Mollica & Finch, 2013).
The company should analyze why the cost of sale is increasing rapidly from 10% in 2013 to 13% in 2014. I would certainly not invest in this company in the short term as the profits are currently non-existent and the situation is worsening. The net income for the last financial period dropped by a significant margin while the cost of goods also increased from 10% in 2013 to 13% in 2014.
Reference
Ross, S. R., Westerfield, R. W., &Jaffe, J. (2013). Corporate finance (10thed.). NY: McGraw-Hill.
Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V., & Finch, N. (2013).
Fundamentals of corporate finance, Pearson higher education au.
Brooks, R., & Mukherjee, A. K. (2013). Financial management: Core concepts. Pearson.
Yahoo Business Finance (n,d) APC retrieved June 25 2015 from http://finance.yahoo.com/echarts?s=APC+Interactive#{%22range%22:%225y%22,%22allowChartStacking%22:true}
Appendix A
| Anadarko Petroleum Corp | Year 2014 | Year 2013 | Year 2012 |
| Net Income | -17,750 | 801 | 2,391 |
| Revenue | 18470 | 14581 | 13411 |
| Assets | 61,689 | 55,781 | 52,589 |
| Equity | 19,725 | 21,857 | 20,629 |
| Debt | 15092 | 13065 | 13269 |
| GP | 15,085 | 11,598 | 10,717 |
Appendix B
Appendix C
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