Corporate Finance Capital Structure - IESE · Corporate Finance Capital Structure Javier Estrada...

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CorporateFinanceCapitalStructure

JavierEstradaSpring,2014

1.Introduction• Wherearewegoing?

2.Tonka• Implications• Limitations

3.Polaroid• Costsoffinancialdistress• Agencycostsandcovenants• Implications

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

IntroductionWhatisthisallabout? Go

Findingthebest(cheapest)waytofinancethelong‐termprojectsofacompany• Whatfinancialinstruments,andinwhatproportions,minimizethecompany’scostofcapital?

• Optimalcapitalstructure xD andxE (orD/E)thatminimizetheWACC

Wewilldothisintwosteps Thepositivesideofdebt

• Thelimitationsoftheset‐up Thepositiveandnegative sidesofdebt

• Theprocessoffindinganoptimalcapitalstructure Go

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

RecapTonka:Assumptions Someareharmless,someareratherimplausible,andsomeareveryimplausible

Tonka:Results AsxD increases,whathappenswithnetincome,EPS,DPS,andtheshareprice?Moredebtcannotalways bebetter

• Theremust betrade‐offs Go

Tonka:UsefulnessWhatitshowsandwhatithides

Targetvariable Tonka:Stockprice(Maximize) Polaroid:Costofcapital(Minimize) Bothtargetsshouldleadtothesame(D/E)*

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

TheCostsofDebtCostsoffinancialdistress Twotypes Go

• Direct• Indirect

Typicallythoughtofasputtingdownwardpressureonthecompany’scashflows

Agencycosts Typicallythoughtofasputtingupwardpressureonthecostofdebt(RD)• Theroleofcovenants Go

Go‐Xls

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructureCriticalresult Ingeneralandinthecase

• TheevidenceclearlyindicatesthattheWACCisnotminimizedataAAAratingWhy?

Latesttrendsinratings Go

Non‐quantitativefactors Notonlyquantitativefactorsarerelevant

• Qualitativefactorsare(very)relevanttoo Go

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Appendix

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Introduction

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Introduction

5

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Introduction

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Introduction

Back

6

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Introduction

Back

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Trade‐Offs

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

Trade‐Offs

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

CostsofFinancialDistress– Direct

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

CostsofFinancialDistress– Direct

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

CostsofFinancialDistress– Direct

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

CostsofFinancialDistress– Direct

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

CostsofFinancialDistress– Indirect

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

AgencyCosts– Covenants

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

AgencyCosts– Covenants

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JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

12

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

13

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

14

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

OptimalCapitalStructure&Ratings

Back

15

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

QualitativeFactors

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

QualitativeFactors

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