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Introduction What is this all about? Javier Go Estrada Finding - PDF document

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Corporate Finance Capital Structure Javier Estrada Spring, 2014 1. Introduction Where are we going? 2. Tonka Implications Limitations 3. Polaroid Costs of financial distress Agency costs and covenants Implications

  1. Corporate Finance Capital Structure Javier Estrada Spring, 2014 1. Introduction • Where are we going? 2. Tonka • Implications • Limitations 3. Polaroid • Costs of financial distress • Agency costs and covenants • Implications Introduction  What is this all about? Javier Go Estrada  Finding the best ( cheapest ) way to finance the long ‐ IESE Business term projects of a company School • What financial instruments, and in what proportions, Barcelona Spain minimize the company’s cost of capital? • Optimal capital structure  x D and x E (or D/E) that minimize the WACC  We will do this in two steps  The positive side of debt • The limitations of the set‐up  The positive and negative sides of debt • The process of finding an optimal capital structure Go MBA CorpFin Spring, 2014 1

  2. Recap  Tonka: Assumptions Javier Estrada  Some are harmless, some are rather implausible, IESE Business and some are very implausible School  Tonka: Results Barcelona Spain  As x D increases, what happens with net income, EPS, DPS, and the share price?  More debt cannot always be better • There must be trade‐offs Go  Tonka: Usefulness  What it shows and what it hides  Target variable  Tonka: Stock price (Maximize)  Polaroid: Cost of capital (Minimize) MBA  Both targets should lead to the same (D/E) * CorpFin Spring, 2014 The Costs of Debt  Costs of financial distress Javier Estrada  Two types IESE Go Business • Direct School Barcelona • Indirect Spain  Typically thought of as putting downward pressure on the company’s cash flows  Agency costs  Typically thought of as putting upward pressure on the cost of debt ( R D ) • The role of covenants Go MBA CorpFin Spring, 2014 Go ‐ Xls 2

  3. Optimal Capital Structure  Critical result Javier Estrada  In general and in the case IESE Business • The evidence clearly indicates that the WACC is not School minimized at a AAA rating Barcelona Spain  Why?  Latest trends in ratings Go  Non‐quantitative factors  Not only quantitative factors are relevant • Qualitative factors are (very) relevant too Go MBA CorpFin Spring, 2014 Appendix Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 3

  4. Introduction Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Introduction Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 4

  5. Introduction Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Introduction Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Back 5

  6. Introduction Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Back Trade ‐ Offs Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 6

  7. Trade ‐ Offs Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Back Costs of Financial Distress – Direct Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 7

  8. Costs of Financial Distress – Direct Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Costs of Financial Distress – Direct Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 8

  9. Costs of Financial Distress – Direct Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Costs of Financial Distress – Indirect Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Back 9

  10. Agency Costs – Covenants Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Agency Costs – Covenants Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Back 10

  11. Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 11

  12. Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 12

  13. Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 13

  14. Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Optimal Capital Structure & Ratings Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Back 14

  15. Qualitative Factors Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Qualitative Factors Javier Estrada IESE Business School Barcelona Spain MBA CorpFin Spring, 2014 Back 15

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