Capital structure

Perfect capital markets should see through the cycle and the reaction of valuations to purely cyclical fluctuations in the industry return on capital should be insignificant. To examine this, we again compared the actual valuation level to a fundamental predicted valuation level for commodity chemical companies. To pinpoint the effects of cyclicality, however, we used a slightly different approach. As we wanted to evaluate capital market expectations, we compared the actual valuation level with a fundamental valuation level based on perfect foresight , i.e., assuming that the capital market knew the actual development of the key value drivers for the next 8 years and evaluated this information in line with its implied fundamental value creation.4 Furthermore, we used a capital structure-adjusted market-to-book ratio instead of an earnings-based metric for the valuation level. 

B. Financial engineering B-1. Optimizing the capital structure B-2. Reducing corporate tax Optimizing capital structure and minimizing after-tax cost of capital of the portfolio company as a consequence of financial knowledge and experience... 

More efficient capital structures and better cash conversion in the USA... 

TABLE 1. Recent changes in Gazprom share capital structure... 

Despite the fact that it may be cheaper to use borrowed capital in place of other types of capital, it is unrealistic to finance each new venture by using borrowed capital. Every corporation needs to maintain a balanced capital structure and is therefore hesitant about placing itself under a heavy burden of debt. 

The discount rate is a weighted average cost of capital (WACC) and takes into account the capital structure of firms, cost of equity and debt, and income taxes. The capital structure of firms is assumed to be 30% equity and 70% debt. The cost of equity capital is 10%, the cost of debt is 7%, and the effective income tax rate is 39%. The debt instrument is assumed to be a 20 year, 7% coupon bond. The calculation of the discount rate is... 

The central financial assumption for the calculation of second generation leve-lized PV electricity and H2 prices is the assignment of the depreciated 10% value of first generation assets as the second generation investment value for equity holders. All other second generation capital investments, revenues, expenses, depreciation, and taxes are entered into the net present value cash flow model in exactly the same manner as the first generation model. The capital structure of H2 production and distribution firms is assumed to remain 30% equity and 70% debt. The rate of return on equity remains 10%, the rate of return on debt remains 7%, the income tax rate remains 39%, and the discount rate remains 6%. 

The definition of net cash flow (NCF) for capital budgeting purposes is after tax cash flows from operations discounted at the present value of the cost of capital.26 In net present value analysis the cost of capital is a pre determined value based on the opportunity cost of capital. The cost of capital is defined as a weighted average cost of capital (WACC) and takes into account the firm s capital structure, the cost of equity and debt capital, and tax rates. The formula for the weighted average cost of capital (WACC) is... 

There are several differences in the financial assumptions. The H2A real after-tax discount rate is 10%, whereas in this study the real after tax discount rate is 6%. The variation is attributable to differences in the capital structure for investments. The H2A uses a 100%-equity capital structure, whereas this study uses a capital structure of 30% equity capital and 70%-debt capital. The cost of debt is 10% for the H2A default value for 7% (30-year coupon bond) for this study. The tax rate is the same in both studies. The H2A assumptions include an inflation factor of 1.29%, while this study does not include an inflation factor, which is explained in Appendix 2. The net effect of these differences in financial assumptions is a lower levelized H2 pump price estimate for this study compared to the levelized H2 pump price under the H2A financial assumptions. 

The assumptions of this study are premised on the commitment to a multi trillion dollar, centralized H2 production and delivery system in the U.S. over a thirty-year time period. Therefore, it is believed that the capital structure assumptions of 30% equity capital and 70% debt are more realistic for the assumed scale of capital investments. In addition, there are cash flow benefits to financing capital budgeting projects with debt capital rather than equity capital because interest on debt is tax deductible whereas dividends payments are not. The 7% interest rate for 30-year coupon bonds is a reasonable assumption for the assumed scale of investments, particularly so if a national H2 plan is adopted with government regulation and guaranteed bond issues. 

In addition to financial sfafemenf analysis, e.g., horizonfal analysis, the rate-of-debt-to-total-assets raho and the hmes-interest-earned ratio can be used to evaluate the capital structure and strategic financial strengths and weaknesses of an enterprise. 

Limited management control via capital structure policy... 

Two major financial considerations of importance to any business are profitability and capital structure. As noted in Chapter 5, some companies in the CPI generate a tremendous flow of cash and profit. To see the significance of these companies, examine their financial ratios and compare them with those of vari-... 

Capital structure is concerned with the ratio of borrowed capital to owner s equity. When inflation is low and the economy is stable, it is frequently cheaper to use borrowed money, if a company can secure lenders. However, a highly leveraged company—that is, one with a high debt-to-equity ratio—faces downside risk when business is bad. Stockholders receive high dividends when profits are good but bondholders expect the interest and principal to be paid on time, with the threat to a firm of insolvency and bankruptcy. Section 8.4.3 shows the effect of debt-to-equity ratio on company operations. Financial officers of companies are concerned with the optimum debt-to-equity ratio. 

The cost of equity capital increases as the firm takes on more debt (%). Empirical estimates of the cost of equity capital for an industry are therefore based on the observed capital structure (i.e., the ratio of debt to equity) in the industry. This approach assumes that the capital structure of firms in an industry is optimal. 

Moreover, information access in real-time resulting from processes such as, for example, checkout counter bar code scanning and satellite location of trucks, fostered mark reductions in delivery lead times on all sorts of goods, from books to capital equipment. This, in turn, has reduced the overall capital structure required to turn out our goods and services, and, as a consequence, has apparently added to growth of multifactor productivity, and thus to labor productivity acceleration. 

The interest rate that will appropriately represent the capital structure of the firm and the risk... 

The minimum interest rate a company should earn on its invested capital is determined by the capital structure of the firm. The firm must earn an adequate return both to support the long-term debt and to compensate the stockholders adequately for their equity investment. This minimum interest rate, Cc, is calculated using the capital asset pricing model and is often referred to as the weighted cost of capital. 

The before-tax rate of return required to support the firm s equity structure would reflect both the risk attributable to equity instruments and the volatihty associate with the firm s stock price relative to the equity market average. The rate of return, required to support the equity portion of the firm s capital structure is... 

As an example of determining the minimum rate of return that must be earned to maintain the capital structure of the firm, consider the following calculation for Johnson Johnson using the data contained in its7999 Annual Report. The data are in Snullion. 

Merton s model is one of the most important models of credit risk. Merton (1974) and Black and Scholes (1973) proposed a model to assess the credit risk recalling the concept of capital structure, according to Modigliani and Miller s theorem (1958, 1963). According to the Black and Scholes s assumptions, at basis of the model the critical ones are two ... 

Leland (1994) developed structural models of default by including taxes and bankruptcy costs, investigating also on capital structure decision. The model is based on two main assumptions ... 

First, the model follows the Modigliani and Miller s theorem in which the firm value is unaffected by the change of capital structure ... 

Leland, H.E., 1994. Corporate debt value, bond covenants, and optimal capital structure. J. Financ. 49 (4), 1213-1252. 

Leland, H.E., Toft, K.B., 1996. Optimal capital structure, endogenous bankruptcy, and the term structure of credit spreads. J. Financ. 51 (3), 987-1019. 

Sundaresan, S., 2013. A review of Merton s model of the firm s capital structure with its wide applications. Annu. Rev. Financ. Ecoil 5, 21-41. 

This chapter defines the term bondholder value and contrasts it with shareholder value. In a second step, the different viewpoints of shareholders and bondholders are examined respectively. The discussion of both parties conflicts of interests concentrates on capital structure, share buybacks, dividend policy, and corporate strategy. As there are also similarities between shareholders and bondholders, instruments of the shareholder value concept that can be used to create bondholder value are described. That includes investor relations, risk management and the balanced scorecard. 

Ivo Welch, A Primer on Capital Structure (working paper. University of California, 1996). 

Conflicts of interest between shareholders and bondholders often relate to capital structure, share buybacks or dividend policy, and strategy. This section discusses these items. 

The question of determining the optimal capital structure has been subject to intensive discussions over the last few decades. Here, we briefly review the theses of Modigliani and Miller (expressed as MM), who proved the irrelevance of capital structure on a theoretical basis, and the traditional point of view, which postulates the existence of an optimal... 

See, for example, Michael J. Barclay, Clifford W. Smith, and Ross L. Watts, The Determinants of Corporate Leverage and Dividend Policies, Journal of Applied Corporate Finance (Winter 1995), pp. 4-19 and Milton Harris and Artur Raviv, The Theory of Capital Structure, Journal of Finance 46 (1991), pp. 297-355. 

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