Monday, 28 January 2019

Capital structure and Leverage

Capital structure and Leverage

The Target Capital Structure

Is the combination between debt, preferred stock, and stock equity used the company to plan a capital gain.

Capital structure Policy involves an exchange between performance risk taking :

  • Use more debt would increase the risks borne by shareholders
  • However, the use of larger debts will usually lead to the occurrence of expectation rate of return on equity is higher
  • Higher risk will lower stock prices, but expectation a higher rate of return would be recognize it. Therefore, the optimal capital structure must achieve a balance between risk and return so as to maximize the company's stock price.

Four factors that may affect the decision of capital structure is :

  • Business risks
  • Tax position
  • Financial flexibility
  • Conservatism or aggressiveness management
  • Business and financial Risk

Business risk is the level of risk in the operation of a company if the company has no debt

= NOPAT ROIC/Capital
= (ordinary shareholders Profit + interest payments after tax)/ Capital

NOPAT net operating profit are after tax and capital is the amount of the debt and equity of the ordinary shares.

If the company has no debt interest payments will then zero, capital will be equal to the equity and value of ROICnya would be equal to taking over ekuitasnya, ROE:

ROIC (zero debt) = ROE = net income ordinary shareholders equity/ordinary

business risks, So the non-leverage (leverage) can be measured by the standard deviation value of ROEnya.

Business Risk is dependent on a number of factors, of which an important factor-factor is :

  • Variability of the company. The more stable demand for the product, no this is considered constant then the lower the risks of its business.
  • The Variability of the selling price. The company sells its products in the market that affected unstable higher business risks.
  • A Variability of input costs. The company that their input is not certain will be exposed to higher business risk.
  • The ability to customize the output prices to changes in input costs. The greater the ability customize output prices to reflect the cost of the condition, the more his business risk. The ability of to develop to new products in a timely and effective in terms of cost. The sooner its products become obsolete so the greater the risk to its business.
  • Foreign risk. Companies that generate most of its profits from foreign operations can be affected by a decline in profits due to exchange rate fluctuations.
  • The composition of the fixed costs. If the majority of its costs are fixed costs so the result does not decline when demand goes down, then the relative business risks tape high.

Operating Leverage

is the level the extent to which fixed costs are used in the operations of a company.

Break-even is the amount of output while EBIT = 0
we can calculate the break even with knowing that a break-even operation occurs when ROE = 0 or when profit before taxes (EBIT) = 0.3

EBIT = PQ-VQ – F = 0
Here P is the average selling price per unit of output, unit output is Q, V is a variable cost per unit and F is the fixed costs per unit. So if looking for a
break-even QBE = F/(P-V)

financial risk

is the additional risk that charged to holders of common stock as a result of the decision to get funding through debt.

Financial Leverage

is the level the extent to which the securities with a fixed profit (debt and preferred stock) is used in the capital structure of a company.

Determine the Optimal Capital Structure

optimum capital Structure is a structure that maximizes the price of the shares of the company, in this case usually request a ratio of debt lower than the ratio that maximize expected EPS.

WACC and Capital Structure Change

managers should choose a capital structure that will maximize the company's stock price. A corporation in respect of capital structure will affect the share price is a difficult thing. But it is known that the capital structure can maximize the stock price is a structure that can minimize the WACC. WACC values will be calculated as follows:

WACC = Wd (Kd) (1-T) + Wc (Ks)
= (D/A) (Kd) (1-T) + (E/A) (Ks)

in this calculation, D/A and E/A is the ratio of debt and equity, and number of two is 1.0.

Exchange theory

Exchange leverage where companies exchange benefits funding Better debt (a favorable corporate tax treatment)

The Theory Of Signaling

The signal is an action taken by the management company which provide guidance to investors about how the company's prospects against the management point of view.

Investors have the same information about the prospects of a company as the Manager it is called symmetric information but in fact, the managers often have better information than investors outside parties. This is called asymmetric information, but has influence on the optimal capital structure.

Using the Debt Funding to limit the Manager

Had stated that the problem can occur if the dignity managers and shareholders have different goals. Conflicts like this particularly large turn it down occurs when the managers of a company has too much money that they can use.

Checklist For decision of capital structure

of companies generally take into account the factors the following factors when making the decision of capital markets:

Stability Of Sales. 

A company selling relatively stable can safely take on more debt and bear the brunt of higher still than in company with sales are not stable.

The Structure Of Assets. The company is suitable as collateral for the loans tend to be more use of debt.

Operating Leverage. 

The Growth Rate. Taxes. Control. The attitude of management. Because no one can prove that a single capital structure will lead to a higher share price than on other capital structure, management can implement their own considerations above the right capital structure.

Companies with fewer operating leverage has a better capability in applying leverage finance because they will have a smaller business risks

The company's rapidly growing should be more relied on external capital.

Profitability. Companies that have a rate of return on investment is very high debt relative to use it a little.

The flower is a burden that can be a deduction on taxes, and tax relief is a very valuable thing for a company with a high tax rate.

The impact of debt versus share on management control position can affect the structure of the capital.

Attitudes of lenders and agents giver of the fastener. 

Without looking at the analysis of the managers of the top contributing factor of leverage is right for their company's own behavior of lenders and agents giver of binder often influence the decision of the financial structure.

Market conditions. 

Market conditions and changing bond in either the short term or long term can provide a sense of what's important in a company's capital structure the optimal

The internal Condition of the company. 

The conditions there are very influential internal corporate structure of capital as an example, suppose a company recently did a research and development with the company and has predicted a high benefit within the time It is no longer

See all the thoughts above give importance on the goal of financial flexibility, that seen from a long operational, it means maintaining an adequate backup lending capacity.

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